A living trust is a legal arrangement established by an individual (the grantor) during their lifetime to protect their assets and direct their distribution after the grantor’s death. It is an estate planning tool that can help family members and beneficiaries avoid a lengthy, public, complex, and sometimes costly probate process.
A living trust takes the form of a legal document. The document lays out the terms of the trust and the assets that the grantor assigns to it. A trustee is designated by the grantor as the individual (or entity) who, at a certain point, will control those assets for the benefit of the beneficiaries.
Key Takeaways
- A living trust is a legal arrangement used in estate planning and set up by someone during their lifetime.
- It designates a trustee and provides explicit directions for the distribution of assets after the death of the grantor.
- A trustee manages assets in a trust according to beneficiaries’ best interests.
- Living trusts can be either revocable or irrevocable, which differ in terms of tax treatment and flexibility.
- Individuals may prefer a living trust to a will because a living trust bypasses the probate process.
How Living Trusts Work
Living trusts are significant in that they allow a trustee to manage the assets in the trust and transfer them to beneficiaries after the grantor’s death.
They begin with the establishment of a trust instrument during the lifetime of the grantor. This is a legal document that lays out the rules and provisions of the trust. Due to their importance and potential complexity, those arranging for a living trust often work with experienced estate planning professionals to ensure a proper setup.
Once the living trust is created, the grantor decides what assets should be in it and then transfers the title of those assets to the trust.
Living trusts are managed by a trustee who typically has a fiduciary duty to manage the trust prudently and in the best interests of the trust’s beneficiaries. Beneficiaries are designated by the grantor when they create the living trust.
Upon the death of the grantor, these assets flow to the beneficiaries according to the grantor’s wishes as outlined in the trust agreement.
A living trust itself can be named the beneficiary of certain assets that would otherwise flow directly to the named beneficiary (regardless of what is stated in a will).
Unlike a will, a living trust takes effect while the grantor is living. The trust does not have to go through probate for assets to reach the intended beneficiaries when the grantor dies or becomes incapacitated.
Assets in a Living Trust
Assets must be assigned to a living trust to be covered by its terms. That means they are re-titled to indicate ownership by the trust.
The types of assets that can be assigned to (or fund) a trust include real estate (land, commercial property, homes), financial accounts, personal property (such as jewelry, artwork, antiques), and business interests.
Specific financial accounts and items can include:
- Stock and bond certificates and safe deposit boxes
- Mutual fund accounts, brokerage accounts
- Money market accounts, certificates of deposit
- Checking and saving accounts, and cash
- Money owed to you
- Life insurance policies
- Non-qualified annuities
You shouldn’t put a 401(k) or IRA in a living trust. That’s because if you change the title (or ownership structure) of, e.g., your employer-sponsored retirement plan, the IRS will see it as an early withdrawal.
That means you’d owe taxes on the amount in your account in the year that the assignment takes place. If you’re less than 59 1/2, you’ll also have to pay a 10% penalty for the early withdrawal.
Types of Living Trusts
The two primary types of living trusts are revocable and irrevocable.
Revocable
A revocable living trust is the most common type of living trust. It is a trust whereby the person who creates it (the grantor) maintains control over the assets placed within the trust. At the creation of the trust, the grantor can designate themself as the trustee. They have the power to change and amend trust rules at any time. They’re free to change beneficiaries, change trustees, remove assets, or terminate the trust.
Revocable living trusts are often used to protect the assets of the grantor should they become ill or otherwise unable to control them. In this situation, the successor trustee will make decisions for the grantor. Revocable living trusts often become irrevocable upon the creator’s death.
Taxes owed on assets in a living revocable trust are still paid by the grantor (while living). However, tax rates don’t increase just because assets are placed within the trust.
Irrevocable
With an irrevocable living trust, the trust itself owns the assets and the grantor can’t designate themself as the trustee. Thus, the grantor relinquishes certain rights of control over the trust. The trustee effectively becomes the legal owner.
Once an irrevocable living trust is created, the named beneficiaries are set and the grantor can do little to amend that agreement. In fact, trust provisions can only be changed in certain, specific situations. Such changes may even require the approval of the courts. In addition, you can never take back the assets assigned to an irrevocable living trust.
There are benefits to having an irrevocable living trust. For one, it protects the assets within it from lawsuits and creditors. That makes them particularly useful to professionals who may be vulnerable to litigation, such as doctors or attorneys.
Also, the grantor can reduce their taxable estate because the trust, and not they, own the assets. In addition, the assets aren’t taken into account where eligibility and costs for government programs such as Medicare and Medicaid are concerned.
Note
Individuals may find it useful to have both a living trust and a will because, for the most part, they perform different functions. Moreover, a living trust goes into effect as soon as it’s created and serves to protect the assets it holds while a person is living. A will goes into effect when a person passes away.
Advantages and Disadvantages of a Living Trust
A living trust is a powerful estate planning tool that allows you to maintain control over your assets while living and make the disposition of your estate an easier matter for your family after your death. As with most things, while it has its advantages, it has some disadvantages as well.
Advantages
- Living trusts offer peace of mind to grantors because their loved ones can avoid the probate process when settling the estate.
- The distribution of assets after death can occur smoothly, quickly, and without court costs.
- In the event that you become incapacitated and can’t manage the trust’s assets yourself, your successor trustee (and not the courts) will manage them on your behalf.
- While you still pay taxes related to the assets in a (revocable) living trust, the tax rate doesn’t increase.
- Living trusts can keep information relating to your estate private.
- They can protect your estate from creditors and legal challenges.
Disadvantages
- A grantor loses ownership of, and control over, assets placed in an irrevocable living trust.
- Any assets to which the grantor owns the title, such as real estate, must be transferred with a legal change of the ownership of title.
- Title transfer involves filing fees to register title changes.
- The creation of a living trust may require the help of an estate lawyer, which also has costs.
- Normally, a living trust offers no tax advantages (unless it’s irrevocable and reduces the size of the grantor’s taxable estate). Taxes would be owed on income generated by assets and on property.
Living Trust vs. Will
Living Trust
A living trust allows you to name beneficiaries and appoint a trustee to manage and distribute trust assets after your death. In turn, it allows your family to avoid the intrusion of probate for property distributed by the trust and other matters related to your estate.
Some individuals establish living trusts simply to avoid probate. However, they can be more complicated and costly to create than a will. Also, they require a notary public.
A living trust cannot designate an executor for a will or name guardians for minor children. Therefore, individuals with living trusts usually draw up a will, too.
A living trust takes effect immediately, once created and signed, and results in you being able to manage, control, and protect your assets throughout your lifetime. It also means that this control, via your instructions in the living trust document, will extend beyond your death to the distribution of the assets to your beneficiaries.
Will
A will is a legal document that names an executor to carry out your wishes after you’re gone. It directs how your assets should be distributed by the executor. It also designates guardians for minor children and includes instructions for other things, such as the payment of debts and taxes, debt forgiveness, and funeral arrangements.
The handling of a will, including the distribution of assets, involves the court-supervised process of probate. Probate is known to take a great deal of time and potentially to be expensive. What’s more, matters relating to a will become public once a probate court is involved.
A will is not a complicated document to create and thus, is less costly than a living trust. It requires a witness to your signature but no notary public. It takes effect upon death or incapacitation.
How to Create a Living Trust
Normally, it’s a smart idea to obtain the assistance of an estate lawyer to establish a living trust. However, here’s a general idea of the steps you’ll take to create one.
- Decide on the type of living trust you need: revocable or irrevocable.
- Designate your beneficiaries and the distribution percentages.
- Name a trustee who has agreed to administer your living trust after you’re gone.
- Complete the living trust document, review it with your estate lawyer, and sign it in the presence of a notary public (a role your estate lawyer may also play).
- Fund the trust with the assets you’ve selected for it.
- Keep the original living trust document stored safely, for instance, in a safe deposit box at your bank (check the contents periodically). Your estate lawyer will probably have a copy. Let your trustee know its location and how to access it when necessary.
Is a Living Will the Same as a Living Trust?
No. A living will is a directive written by an individual granting power of attorney and other rights to a trusted other if that individual becomes incapacitated or loses the ability to communicate. A living (or inter vivos) trust establishes a legal entity (the trust), which holds assets that can be distributed without probate to beneficiaries after one’s death.
How Much Does a Living Trust Cost?
Establishing a living trust usually requires an attorney. Depending on the attorney and the complexities of your living trust, it will cost between $1,100 to $1,500 for an individual and $1,700 to $2,500 for a couple. You can cut down on these costs by creating one yourself or using an online service.
What Are Some Disadvantages of Living Trusts?
The downsides of trusts, aside from their cost, will depend on whether it is a revocable or irrevocable trust — each of which serves its own purpose. A revocable trust is not sheltered from tax authorities or creditors, which limits its usefulness as a way to protect assets while one is still alive. An irrevocable trust involves forfeiting all ownership and control of the assets put inside of it, along with very little flexibility in how the trust can be directed after it is established.
The Bottom Line
A living trust can be a very important legal arrangement for people with assets that they wish to control and protect during their lifetimes and beyond. Normally, it provides those who establish and fund them, the grantors, the power to control and benefit from their assets while living and direct how they should be distributed once they’ve passed away.
Living trusts normally bypass the time-consuming, costly probate process and facilitate the smooth transfer of assets to beneficiaries.
Related Terms: will, probate, trustee, assets, beneficiaries.
References
- American Bar Association. “Revocable Trusts”.
- Northwestern Mutual. “Which Assets Belong in a Trust?”
- Fidelity. “Trusts and Taxes: What You Need to Know”.
- Federal Deposit Insurance Corporation. “Irrevocable Trust Accounts (12 C.F.R. § 330.13)”.
- The American College of Trust and Estate Counsel. “ACTEC Estate Planning Essentials: Can I Change My Irrevocable Trust?”
- American Bar Association. “Young Lawyers Network: Tax and Non-Tax Considerations when Drafting Irrevocable Trusts”.
- American Bar Association. “Introduction to Wills”.
- Cabot Wealth Network. “How Much Does a Living Trust Cost and Is It Worth It?”
