8 Disadvantages of Revocable Living Trusts

The primary purpose of a revocable living trust is to manage and distribute a person’s assets during their lifetime and after death. The revocable trust avoids probate if all assets are placed in the trust. You also retain control of your assets if you name yourself as the trustee. When you die the trust becomes irrevocable and named trustees take over the management of the trust.

The revocable living trust is the workhorse of estate planning. It is easy to change at any time as long as you are competent and generally allows for the bypass of probate. Best of all, assets in the revocable trust are still owned by you. Yet, as powerful a tool as the revocable trust is, there are disadvantages you need to consider.

What Does It Cost To Set Up a Revocable Living Trust?

A will is relatively inexpensive to have prepared. Attorney fees generally are a few hundred dollars for most wills.

A revocable living trust, on the other hand, is much more expensive to set up and maintain. A simple revocable living trust with a modest number of assets can cost several thousand dollars to set up. Periodic updating in required, especially when assets change. Updates are subject to additional costs.

What Assets Never Go Into a Revocable Trust?

Some assets never go into a revocable living trust. These include:

• Retirement Accounts: Transferring your 401(k), traditional or Roth IRA, 403(b), 457, and certain qualified annuities should never be transferred to a revocable trust because it requires a withdrawal, triggering income tax on the distributed money. Since you can name primary and secondary beneficiaries on these accounts it is not necessary to transfer these assets to a revocable trust.
• Health Savings Accounts/Medical Savings Accounts: A living trust should never accept these assets. They are already tax-free tools for qualified medical expenses. As with retirement accounts, primary and secondary beneficiaries can be named.
• Uniform Gift (or Transfer) to Minors Accounts (UGMA/UTMA): These accounts are set up to benefit minor children and become an asset of the child once they reach the age of majority. Transferring these types of accounts to your revocable living trust risks dragging the trust into probate court should the trustee predecease the child.
• Active Financial Accounts: Often the grantor, you, list yourself as trustee of the revocable trust. If health or other considerations have you list someone else as trustee you will want to retain control of liquid some assets to pay your bills. Generally, the grantor keeps a bank checking account outside the trust for these purposes. You can add beneficiaries to these bank accounts by using the payable-on-death option.
• Vehicles: Depreciating assets generally are not placed into a revocable living trust. Your car, boat, snowmobile, and similar assets often do not go though probate anyway so there is no reason to place them into the trust. The exception would be collectible vehicles or antiques.

What Are the Disadvantages of Putting Your House Into a Trust?

You might be tempted to place your house in a revocable living trust. Here are a few reasons why that may not be the best plan:

• Loss of Direct Ownership: While you generally retain control of your assets in a revocable trust (if you are the trustee), you no longer have direct ownership. There is the possibility lenders will refuse to lend on such a property or lend at unfavorable terms.
• No Asset Protection: Revocable living trusts provide no asset protection. Lawsuits and creditors can make claims against your home during your lifetime. Irrevocable trusts provide better protection.
• Tax Disadvantages: Under current tax law, a home in a revocable living trust transfers to beneficiaries with a step-up in basis at the date of death. The Section 121 exclusion also applies. However, there is no step-up in basis for the grantor. No tax deductions exist for transferring your home into a revocable trust.

You are allowed to transfer real estate in an LLC to a revocable trust. Income property can still be transferred to the revocable trust as a result.

Placing your home in a revocable trust offers limited, if any, tax advantages. There are other tools, like the qualified personal residence trust, that are better suited for optimizing tax strategies.

Does a Revocable Living Trust Reduce (or Increase) My Taxes?

Again, the revocable living trust is a grantor trust. You retain control over your assets as long as your are the trustee. Upon death, your beneficiaries receive a step-up in basis and Section 121 can still apply.

Assets in the revocable trust are still taxed to the grantor. There is no separate tax return until the death of the grantor, when the trust becomes irrevocable and a separate return is needed.

Can I Set Up My Own Revocable Living Trust?

While it is not illegal to set up your own revocable trust, it is unadvisable. Revocable living trusts are complex instruments requiring a seasoned attorney. You may also wish to work with an accountant versed in estate planning issues. Your attorney and accountant working together are a powerful team for protecting your assets.

Are Revocable Trust Assets Excluded From Medicaid Eligibility For Long-Term Care?

No. Assets in a revocable trust are still included when assessing for Medicaid eligibility for long-term care.

An irrevocable trust is needed to exclude assets from Medicaid eligibility for long-term care. You can read more about the Medicaid Asset Protection Trust here. It should be noted that assets transferred to an irrevocable trust lose the step-up in basis at death. Gift tax may be involved. And the trust may be required to file a separate tax return and pay tax at the entity level.

What Are the Downsides To a Revocable Trust?

As powerful and useful as the revocable living trust is, there are downsides.

1. Cost.
2. Taxes. There are no tax benefits with a revocable trust. No real additional tax liabilities either.
3. Limited Asset Protection. The revocable living trust does provide privacy, but creditors and lawsuits can put assets at risk. Therefore, asset protect is very limited.
4. Complexity. The revocable trust takes time. Transfer of assets is required. Recordkeeping and other paperwork add to the workload. Some attorneys will handle some of these issues.
5. Medicaid Issues. Revocable living trust assets are still considered for Medicaid eligibility for long-term care.
6. Transferring Assets. Once the trust is set up the assets need to be transferred to the trust. In my tax often I see many examples of clients with a revocable living trust with no assets transferred to the trust. If your attorney does not handle the transfer, you will need to facilitate the transfer of assets yourself. Some accountants help with this. It never hurts to ask.
7. Probate. Often a pour-over will is used to catch all assets not placed into the trust. Assets not properly placed in the revocable trust will have the need for probate.
8. Lack of Court Supervision. There is no court oversight with a revocable trust. If you are the trustee while you are alive it is not much of an issue. But once you die the lack over court supervision can lead to mismanagement and disputes. The same applies if you are not the trustee while you are alive.

What Is the Greatest Advantage Of a Revocable Trust?

We spent plenty of time on the disadvantages of revocable trusts. However, the revocable trust is a powerful tool when estate planning.

The greatest advantage of the revocable trust is the avoidance of probate. Probate is public. Creditors find it easier to file claims in probate court. Lawsuits, too. Probate is also expensive. Attorney and trustee fees can become significant.

Avoiding probate on properly transferred assets allows for quicker distribution of assets to beneficiaries. It allows you to also set the parameters of the distributions. Just handing all your assets to your children upon death can destroy their lives. A plan is needed to carry out your wishes.

All this and flexibility. That is what the revocable living trust offers. As long as you keep the disadvantages in mind, you have the advantage.