A trust is a legal entity that is separate from you and can own assets, conduct transactions, and operate under its own rules. Every trust has three key roles: the grantor who places assets into the trust, the trustee who manages the trust, and the beneficiary who ultimately benefits from the assets. Trusts generally fall into two categories: revocable and irrevocable. With a revocable trust, you retain full control and can move assets in and out whenever you want. This flexibility makes it a common tool in estate planning because it can be changed or revoked during your lifetime.
The primary reason people use a revocable trust is to avoid probate, which is the state-specific legal process that distributes assets according to a will after someone dies. Probate can be time-consuming, expensive, and public. Assets held in a revocable trust bypass probate because the trust itself specifies how those assets should be distributed. This allows the transfer of assets to happen more efficiently and privately. While most people need a will, many high-income professionals also choose to set up a revocable trust once their wealth grows, often sometime during mid-career.
Setting up a revocable trust usually involves working with an estate planning attorney and may include updating other estate documents such as a will, living will, or powers of attorney. After creating the trust, it must be “funded” by retitling assets like brokerage accounts, bank accounts, or real estate into the name of the trust. For tax purposes, revocable trusts are typically treated as pass-through entities while you are alive, meaning income is reported on your personal tax return. It is important to note that revocable trusts do not provide asset protection from creditors; their primary purpose is estate planning and probate avoidance, not shielding assets from legal claims.
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Let’s talk about revocable trusts.
First of all, what is a trust? A trust is an entity that is separate from you. It can own things, conduct transactions, and engage in business activities, but it is not you personally. It is something distinct, similar to forming a corporation or an LLC. Any trust has three key roles. There is a beneficiary, the person who ultimately benefits from the assets in the trust. There is a trustee, the person responsible for running the trust and managing the assets. And there is a grantor, the person who puts the assets into the trust in the first place.
There are two main types of trusts: revocable and irrevocable. With an irrevocable trust, once you place assets into the trust, the trust owns those assets and you generally cannot take them back. A revocable trust works differently. With a revocable trust, you can put assets into the trust, pull them out the next day, put them back the following day, or move them around however you want for the rest of your life. That flexibility is one of the key features of a revocable trust. It is not permanent and can be changed or revoked at any time.
So why would someone use a revocable trust? The main reason is to avoid probate. Probate is a state-specific legal process that reviews your will and determines how your assets are distributed after you die. The advantage of a trust is that it has its own rules that you create regarding how the assets are distributed. Because the assets are owned by the trust rather than by you personally, they do not have to go through the probate process.
This can be important because probate can be expensive and time-consuming in some states. If you want to avoid that process and the associated costs, placing assets in a revocable trust before you die can accomplish that. Technically, you could create the trust shortly before death if you knew exactly when you were going to die. Of course, most of us do not know that, and we may also face health or cognitive issues later in life. Because of that, it often makes sense to set up a revocable trust earlier rather than waiting until the last minute.
Another advantage of avoiding probate is privacy. Probate is a public process, which means that people can potentially see what assets you owned. A trust, on the other hand, is generally private. The distribution of assets through the trust does not become part of the public record.
Most people need a will, but not everyone needs a trust. However, many White Coat Investors prefer to avoid probate, so they often choose to establish a revocable trust at some point before they die. When should you set one up? There is no perfect rule of thumb. Some people suggest doing it once your net worth reaches seven figures. There is nothing magical about that number, but it is a reasonable guideline. It means you are not doing it at the very beginning of your career, and you are not waiting until well into retirement to put it in place.
What does it cost to set up a revocable trust? It can be relatively inexpensive, but it is generally not a good idea to simply use an online template without guidance. By the time you are considering a trust as part of your estate plan, you are usually financially comfortable enough to obtain professional advice. It is wise to work with a qualified estate planning attorney in your state. During that process, you can also review other important documents such as your will, a living will, powers of attorney, and other components of a comprehensive estate plan. This is also a good time to determine whether estate taxes may be a concern and whether more advanced planning strategies, such as irrevocable trusts, might be appropriate.
Once the trust is created, you must fund it. Simply setting up the trust is not enough. You need to move assets into the trust by retitling them. For example, if you want a brokerage account to be part of the trust, the account must be titled in the name of the trust rather than in your personal name. The same applies to bank accounts, vehicles, real estate, and other assets. Funding the trust can take some effort, but it would make little sense to pay for the trust and then leave it empty.
From a tax standpoint, revocable trusts are generally pass-through entities while you are alive. This means the income generated by the trust is reported on your personal tax return, and you do not need to file a separate trust tax return. After you die, however, the trust becomes a separate entity. At that point, it may need to file its own tax return and will be subject to trust tax rates, which can become quite high at relatively low levels of income.
Some people think trusts are useful for asset protection, but that is not the case with revocable trusts. Asset protection typically involves strategies that protect assets in situations such as bankruptcy. For example, retirement accounts often receive strong protection under bankruptcy laws. A revocable trust does not provide that type of protection. Because you can revoke the trust and access the assets at any time, creditors can generally reach those assets if there is a legal judgment against you. If you were to declare bankruptcy, the assets in your revocable trust would still be accessible to creditors.
If asset protection is the goal, that generally involves irrevocable trusts, which come with additional costs, restrictions, and downsides. Revocable trusts are primarily an estate planning tool used to simplify the transfer of assets and avoid probate, not to shield assets from creditors.
I hope this overview helps you better understand the purpose and benefits of a revocable trust.
The White Coat Investor Podcast is for entertainment and informational purposes only and should not be considered financial, legal, tax, or investment advice. Investing involves risk, including the possible loss of principal. You should consult the appropriate professional for advice specific to your situation.
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