What is a living trust?
A living trust is a legal arrangement where the trustor, otherwise known as the grantor, gives assets to a trustee to manage on behalf of a third party, the beneficiary. A living trust goes into effect while the trustor is still alive, whereas a testamentary trust is created after the trustor has died. A living trust can take effect immediately upon inception, at a later specified date, or when a specific event takes place, such as the grantor becomes incapacitated.
Living trusts are created to:
- Plan for the management of assets in the event the trustor becomes incapacitated.
- Plan for the care of minor children or other dependents upon the death of the trustor.
- Avoid assets going into probate upon the death of the trustor.
- Maintain privacy, as assets that go into probate are often public record.
Trust property are the assets owned by the trust. Trust property can include any type of assets, including cash, real estate, life insurance policies and security investments.
Revocable trusts provide the trustor the ability to make changes to the trust. While the trustor is alive, he or she can add or remove assets, change beneficiaries or change the trustee. The trustor also has the right to revoke the trust. Because trustors of revocable living trusts maintain control over the trust while they are living, these trusts are still subject to estate taxes, which are due when the assets are transferred to the trustor’s heirs.
Irrevocable trusts cannot be altered or revoked after they’re created. By creating an irrevocable trust, the trustor is relinquishing all rights and responsibilities to the trust. While trustors can act as the trustee for a revocable trust, they’re prohibited from acting as the trustee for irrevocable trusts. Some of the uses for irrevocable trusts are:
- To reduce taxes by reducing the trustor’s income.
- To shield the proceeds of a life insurance policy from taxation.
- To provide financial aid to an individual with special needs.
A trustee is appointed by the trustor and can be anyone the trustor has confidence in to effectively manage the trust. They can be friends, family members or professionals, such as attorneys or financial advisers. A trustor may also appoint herself as the trustee until the time of her death.
Trusts must be funded to be properly established. This requires that the trustor transfer the assets into the trust before his or her death. Once the assets are owned by the trust, the trustee is responsible for managing the assets, as specified by the trust.
Living trusts are expensive to establish and manage. While they’re sometimes used to avoid probate, most states offer an expedited probate process for estates under a certain dollar threshold, which varies by state. If your estate meets the expedited probate criteria, creating a trust may not be necessary. Additionally, if your home and other assets are jointly owned, these assets will be automatically transferred to the joint owner. Retirement plans, pensions and life insurance policies are automatically transferred to your beneficiaries.
Examples of a living trust
Living trusts are right for some people, but most people won’t need them. Here are some situation where establishing a trust may make sense:
- If you own property in another state, such as a vacation home, a trust may protect the property from going into probate in that state.
- Trusts are harder to contest than wills. If you plan to leave one child more money than another, setting up a living trust may ensure your assets are distributed appropriately.
- If you have dependents with special needs, a trust allows you to exercise control over how their assets are managed.
- If your estate exceeds the estate tax threshold, establishing a trust may limit your tax liability.