A living trust (aka grantor trust, inter vivos trust) is a trust set up and managed by the grantor while he is still alive to be primarily used as an estate-planning tool, with a primary purpose of avoiding the expense and delay of probate. A living trust can also be set up so that it only springs to life based upon a contingency, such as a spouse predeceasing the grantor. However, a living trust that is revocable does not protect against creditors, taxes, or the claims of ex-spouses. An irrevocable trust may offer some protection, but then the grantor loses control of the trust property and its income. A pour-over will will still be necessary to receive property that has not been placed in the trust.
The most common steps for implementing a living trust is to write the trust documents, naming yourself as the trustee, designating one or more successor trustees, then transferring your property into the trust.
Advantages and Disadvantages of a Living Trust
The primary advantage of a living trust, of course, is to avoid the expensive and time-consuming process of probate, when it could be several years before your beneficiaries receive any of their bequests. This is especially true for realty owned in more than one state, since probate must be conducted in each state where the real estate is located. Another benefit of a living trust, unlike a will, is that it is not a public record, so the distribution of property can remain private. If you become incapacitated because of accident or illness, management of your assets can easily be transferred to your successor trustee; otherwise, without a living trust or durable power of attorney, the court would appoint a conservator to manage your assets, which could be costly.
Living trusts are simple to establish and much easier to change than a will, since they do not require the legal formality required to change wills. Therefore, both setting up and making amendments are much easier. For instance, to make amendments, you can simply write the changes in your trust document, then have it notarized and attested by at least 2 witnesses. However, consult specific state law in this regard. Furthermore, the trust document does not have to be rewritten or amended if you move to a different state. A will must be rewritten or amended to conform to the new state laws. Although trusts, like wills, can be contested, it is generally much more difficult to contest a trust, depending on state law. The Uniform Trust Code, for instance, allows beneficiaries to contest a trust. There are no complications to the taxation of living trusts, since the assets and any income earned from those assets are reported on the grantor's tax return. Hence, every tax-saving strategy that individuals can use can also be used for a living trust.
There are also disadvantages to a living trust. A trust document and a pour-over will must be prepared. The pour-over will receives any property not owned by the trust when you die, but all debts, taxes, and expenses of the estate must be paid before any property is transferred to the trust. Real estate and other titled property, such as automobiles, will require the payment of some fees. The mortgage company may also charge to transfer the mortgage. If your state has a homestead law that reduces property taxes, then the homestead reduction may be eliminated by transferring it to a trust. However, the home sale exclusion of $250,000 ($500,000 for married couples) of profit from federal taxation after selling the home is still available even if the trust owns it. Additionally:
- Stock in a professional corporation may not be transferred to revocable trust because only professionals may own the stock.
- §1244 stock held by a revocable living trust may not qualify for ordinary loss treatment.
- Deducting income set aside for charitable purposes cannot be deducted by trusts.
Although divorce will automatically remove the ex-spouse as a beneficiary of a will, a trust document must be amended to remove an ex-spouse as a trust beneficiary.
Setting Up a Trust
When setting up a trust, decisions must be made regarding trustees, guardians, and the distribution of principal and income from the trust to the beneficiaries. A professional trustee, such as a bank or trust company, can help but can also be expensive. Nonetheless, one advantage of hiring a professional trustee during your lifetime is that you can evaluate the trustee.
Most living trusts are revocable, since it offers the greatest flexibility, allowing you to manage the property much as you did before transferring it to the trust. However, an irrevocable trust will sometimes be chosen to protect the assets from creditors, but state law varies widely concerning the amount of protection provided by an irrevocable trust. The grantor must give up all control of the property. An irrevocable trust may also offer some tax advantages, since assets can be excluded from your probate estate, allowing the assets to appreciate without increasing the size of your estate. However, an irrevocable trust, as a separate taxable entity, must file its own tax return.
A trust should be fully funded so that probate can be avoided for most of your property in cases of sudden death. Married couples should use 2 trusts, one for each spouse. However, a revocable trust offers no protection against the claims of an ex-spouse in a divorce proceeding.
A successor trustee should be chosen so that she could take over in case you become incompetent or die suddenly. Often, a successor trustee will be a close family member or a professional trustee. A durable power of attorney can also allow someone else to put your property into a trust if you become mentally incapacitated.
If the trust is to contain all of your property, then a pour-over will should be drawn up, so that the trust can receive any of your property that is not trust property, such as your last wages. Additionally, most people do not title all their property to the trust when they acquire it, especially property held for only a short duration, since some effort is required to either title the property in the name of the trust or to list the property in the trust document. A pour-over will can transfer that property into the trust.
Funding the Living Trust
Property must be titled in the name of the trust or there must be some indication that the trust owns the property. There are various ways of designating the trust ownership of property, such as "John Doe, Trustee" or "John and Jane Doe, Trustees, and their successors, of the John and Jane Doe Irrevocable Trust."
Certain property may have certain requirements for transferring title to the trust. Some states, for instance, require filing the trust document with the court if there is a transfer of real estate into the trust. To transfer securities, title agents may require a copy of the trust document. Banks may also require a copy of the trust document for accounts or for safe-deposit boxes for the trust. These requirements generally arise because the involved parties require some proof that the trust actually exists and that you actually have authority to act on its behalf. However, giving copies of the trust document to many people allows them to see your financial affairs. To avoid this, and to give people the proof that they need that the trust actually exists and that you are the trustee, an affidavit of trust, or what is sometimes also called a certificate of trust, can be drawn up and notarized. The affidavit of trust lists the trustees, successor trustees, the name of the trust, and whether it is revocable or not.
A nominee partnership can also be created to hold real estate for the trust. Generally, the partners are the trustees. A nominee partnership owns real estate on behalf of the trust. Unlike a regular partnership, there is no capital or income for the partnership; it is simply created for holding real property that, for legal reasons, cannot simply be held by the trust, or to avoid the necessity of recording the deed in the Registry of Deeds in the county in which the property is located and to avoid the public disclosure that the trust owns the property.
The ownership of real estate is evidenced by a deed, which must be filed with the court. Additionally, real estate mortgages generally have a due-on-sale clause when title is transferred, so if you have a mortgage, contact your lender for the required procedure to transfer the property to your living trust. If your state has a homestead exemption, then contact the County Clerk to maintain the homestead exemption, if possible.
Generally, bank and brokerage accounts can be transferred to the trust with little difficulty. The easiest method for bank accounts is to simply open new accounts in the name of the trust, then transfer the money to the new accounts. If securities are held in the street name of a broker, then simply transferring the brokerage account to the trust will also transfer the securities. However, if individual stocks or bonds are owned directly by you, then the broker must be contacted so that the titles can be transferred to the trust. Insurance policies can also be easily transferred to the trust, but there may be some benefits to transfer any life insurance policy to an irrevocable trust, since it will not be part of the estate as long as the grantor did not have any incidents of ownership of the policy within 3 years before death.
Retirement accounts have beneficiaries that are listed in the appropriate documents, so they must be changed if the beneficiaries are changed. If you are married, then your spouse cannot be removed as a beneficiary without her consent in writing. A living trust can be the designated beneficiary of qualified retirement accounts if:
- the trust is valid under state law
- the trust beneficiaries can be identified
- the trust is irrevocable or will be upon the death of the owner; and
- certain documentation is provided to the trustee or custodian.
If the trust does qualify as a designated beneficiary, then the required minimum distribution (RMD) from the plan will be based on the life expectancy of the trust beneficiary; if there are several, then the RMD will be based on the shortest life expectancy of the trust beneficiaries. If the trust fails to qualify as the designated beneficiary, then the plan proceeds must be paid over the participant's remaining life expectancy if death occurred after reaching age 72, or before the end of the year after the year of the participant's death if it occurred before age 72.
Generally, the procedure to transfer vehicles and boats to the trust varies widely from state to state, so it may be advisable to consult an attorney for transferring these types of property. But, a title certificate can usually be transferred to another owner on the certificate itself.
Transferring property with no title may be problematic. Most tangible personal property does not have a title, including clothes, furniture, tools, jewelry, and most other personal property. Because personal property changes frequently, it makes sense to include a clause in the trust document that all tangible personal property owned now or later by the settlor (you) is included in the trust. Nonetheless, trust ownership of personal property can easily be contested. A pour-over will can transfer the property to the trust upon your death. Although the property will go through probate, the distribution of the property will remain private, since your successor trustee will be distributing the property.
Note that the time and cost of probate can only be partially avoided. The trustee will still have to file an estate tax return to pay taxes, and creditors must be notified of your death so that they have the opportunity to file a claim with the personal representative of the estate for any remaining debts. Remember that a living trust does not save on taxes nor does it protect assets from creditors. Additionally, the proceeds of any life insurance policy that is transferred to an irrevocable trust will be included in the estate of the grantor if death occurs within 3 years of the transference.