If you have loved ones, perhaps you’re asking whether a living trust may be right for you? This article will help you understand what is a living trust. Armed with some knowledge, we will then review our top 7 benefits when using a living trust for your estate planning, so you can make the right decisions, and get your financial affairs in order.
What is a Revocable Living Trust?
A LIVING TRUST IS AN AGREEMENT entered into during the lifetime of the trustmaker which concerns a few specific parties for the purpose of holding, managing and distributing the estate assets that are titled in the name of the trust.
The parties to a living trust agreement are:
- grantor (a/k/a settlor, trustor, or trustmaker)
- trustee (and successor trustee)
- trust protector (in some cases)
The grantor is the person who creates the trust by transferring estate assets to it. The trustee is the appointed person or company to manage the trust assets for the beneficiaries who are to receive designated income and/or principal from these assets. Sometimes a third party is designated as a trust protector, who is empowered to take certain measures to prevent problems and preserve the intent of the trust.
Revocable vs. Irrevocable Trusts
Whether a LIVING TRUST is a revocable vs irrevocable trust is defined by the trust agreement and depends upon the intent of the trust.
A living trust (aka inter vivos trust) means that this trust has been formed by the grantor while he or she is still living, as opposed to the type is directed to form upon the grantor’s death.
Trusts that form upon a grantor’s death are typically defined as a testamentary trust created by a will, so these are NOT living trusts. Most of the time, when people refer to a living trust, they are talking about a revocable living trust because they are contrasting it with the, also widely used, testamentary trust. With that in mind, technically, living trusts could include both revocable and irrevocable varieties.
Revocable says that this is a unique type of trust that may be revoked (cancelled, annulled, terminated or amended) by the grantor after the trust has been formed. The “revocability” of the living trust makes it very flexible and also suitable for very specific estate planning purposes, to be discussed shortly.
Irrevocable trusts are used for some of the same purposes as revocable trusts with a few key differences.
Because a revocable living trust may be revoked at any time, it doesn’t work well for the various purposes mentioned above that are suited for irrevocable trusts.
Because irrevocable trusts are independent entities which have their own tax id number and a responsible to file independent tax returns, they are great for transferring money for asset protection safety OR serving as a way for the grantor to reduce the size of their estate and thereby limit estate taxes.
They are also ideal for “gifting” to younger generations and for holding assets outside of the grantor’s estate for pre-Medicaid planning.
Practical Tip: It’s all in the way the attorney drafts the trust because the language of the trust spells out the legal structure of the agreement and makes the trust what it is.
There are lots of different kinds of trusts, referred to by all kinds of fancy legal jargon. To name a few, there are revocable living trusts AND many types of irrevocable trusts with fancy names like asset protection trusts (foreign and domestic), Irrevocable Life Insurance Trusts (ILIT), and charitable trusts, and GRATs and GRUTs. These irrevocable trusts and other fancy named varieties are all part of a smorgasbord of legal options designed for a wide variety of goals and circumstances.
Having already focused on the top pros and cons of revocable vs. irrevocable trusts, this remaining article will dive into the unique estate planning benefits offered by living trusts in general.
A Word About Testamentary Trusts
A living trust is named this way to distinguish itself from its popular counterpart, the testamentary trust. Unlike a living trust, a testamentary trust is NOT formed until the death of the trustmaker. Typically a testamentary trust would be included as part of a last will and testament AND is often used to create a trust for underage beneficiaries. The advantage to a testamentary trust is there is no further action needed to set this up during the trustmaker’s lifetime. Among the disadvantages testamentary trusts are that they do NOT avoid the probate process, but are formed in probate, and they also are ineffective for disability or special needs planning or any of the various other benefits that are achieved with living trusts.
Living Trusts [Top 7 Benefits]
Setting up a living trust the right way offers many estate planning benefits which, depending upon the estate, may include the following:
- avoid probate
- managing beneficiaries
- spousal planning
- estate tax planning
- life care for dependents
- special needs planning
- business succession planning
Avoid Probate with Living Trusts
If you heard anytime about living trusts before diving in today, you’ve probably hear this one because it is one of the most touted reasons for getting into the living trust game. Not to say this isn’t a good reason.
Actually, avoiding probate is the original reason that living trusts were invented way back in merry old England as way to keep real property OUT of the probate process which was operating by the church at that time. Trusts were actually a solution to the problem of having to answer to a judge about who and how to distribute real property to heirs.
Today, the probate process in most states is a royal pain in the backside. In general extremely high legal costs (Attorney fees in CA can be up to 4% of the estate’s value) accompanied by an overburdened probate court system results in a very extended timeline to get things done. In other words, your real estate deal might be derailed.
So, take heart, your living trust can save the day by allowing your trustee to expedite a quick and private sale, provided no other issues are interfering of course.
Managing Beneficiaries with Living Trusts
This living trust benefit is also great because if you’re kids are in their teens and you’re specifying what they all get from your estate, you’ll want some flexibility to change thing in the years to come.
After all, what if Timmy, who was once your favorite, turns into a major disappointment, while your former drama queen, Sally, evolves into the faithful daughter you’d always dreamed about.
The benefit is you can change a living trust (the revocable type) in the event of prison, drug use, bankruptcy, massive debt. It happens.
Spousal Planning with Living Trusts
Spousal planning becomes very important is a number of different scenarios. Sometimes assets are transferred from one spouse to another as a Medicaid planning strategy.
Second marriages, with children from prior marriages, also will require spousal planning.
For example, a living trust created by one spouse can designate certain assets to be held for the surviving spouse’s life, and then distributed to the grantor’s children upon the surviving spouse’s death.
Of course, for any spousal planning strategy, flexibility is key, not only if she decides to run off with the pool boy, but for any number of reasons which include her untimely demise, not necessarily connected with that pool boy incident.
Estate Tax Planning with Living Trusts
Another aspect of spousal planning is federal estate tax planning; however, its separated here because a living trust can also be a kind of “conductor” for assets as needed to minimize estate taxes for unmarried people.
The federal estate tax is a lump sum tax that is levied by the federal government based upon the value of the deceased owner’s gross estate. This tax would be correctly described as a death blow for some business owners and especially those with less than ideal estate liquidity.
Life insurance for estate planning is often used as a means to soften the blow of federal estate taxes.
Married couples get double the exemption of assets. Under recently updated 2018 tax laws, this means that an unmarried person can pass $11,200,000 in exempt assets and a married couple can pass almost $22,400,000 without federal estate taxes.
A family living trust (typically husband and wife) or a joint trust with two grantors can be used to shift assets between the spouses upon death as a way to most effectively use the deceased spouse’s exemption amount. This is done typically in a joint revocable living trust by providing a legal means within the trust to create separate trusts upon the first spouse’s death, thereby creating a protected second trust for a surviving spouse. This separate trust as well as the remaining trust estate can pass without federal estate taxes using this approach.
A QTIP (Qualified Terminal Interest Protection) Trust may also be used by a grantor spouse who wants to protect part of the estate for the surviving spouse and also keep control of the distribution when the surviving spouse passes.
Another way for a living trust to maximize estate tax planning is to create a charitable lead trust or charitable remainder trust. This approach in general will allocate some of the estate to a legitimate charity (either income or principal). And through this strategy, which is based upon a somewhat complicated formula, the trustor may use it to avoid or minimize estate taxes.
Life Care for Dependents with Living Trusts
When you think of dependents, your brain might go right to your kids. Many older children are still living at home, for various reasons, including the high cost of real estate and rent. As a result, aging parents who live with adult children are a common estate planning concern. A living trust allows a way to include these beneficiaries in the plan by allowing them to receive a “life interest” in certain trust assets, particularly real property.
Trust assets may also be used to pay expenses as needed. Flexibility is ideal here, because if your life beneficiary were to pass away or move to a nursing home, the trust may be amended. Even if the trust is never updated, typical living trust language will provide an alternative beneficiary plan.
Special Needs Planning and Living Trusts
If you have a beneficiary with special needs, he or she may need to get qualified for “need based” government assistance known as SSI disability. If that special needs beneficiary receives any part of an inheritance as an outright gift, it will disqualify them from assistance and this is true even if they decline the gift.
The work around on this issue is to form a special needs trust, and this can be done within the revocable living trust or as a separate irrevocable trust. Because the special needs trust would NOT become effective until the grantor’s death, the special needs trust can be cancelled if the condition or the beneficiary passes.
You might need to change the trust due to a beneficiary having been qualified for government assistance such as SSI disability. In this scenario, an outright distribution of assets to the beneficiary would disqualify them from benefits and thus a special needs section would need to be added to a revocable living trust and you can do it anytime! Or you can do a stand alone irrevocable special needs trust which is a specific type of irrevocable trust.
Special needs planning is closely related to long-term care planning AND potentially Medicaid planning. The important thing to know is that a living trust can provide protection and flexibility for both trustmakers and beneficiaries who either become incapacitated or otherwise require long-term care, such as skilled nursing care.
Business Succession Planning with Living Trusts
I like this one the best, because a living trust is so useful as a conductor for ANY type of family business planning.
Business succession planning or family business succession planning refers to a plan created for a business to continue operating in the event that an owner-partner dies or becomes disabled.
On one hand, ALL business owners must have certain documents for maintaining business continuity through succession planning such as a buy-sell agreement and/or an operating agreement and these agreements MUST specify how things will go if an owner-partner dies or becomes disabled.
However, these documents only heighten the value of integrating the business succession plan into a living trust.
For example, if a wife owns a business and her business partner is appointed to purchase it upon her demise as described in her business succession plan, her trust should also specify the intended business sale and the other documents that are needed. It will be her successor trustee, let’s say her surviving husband in this case, who will negotiate with his late wife’s business partner and the living trust makes this a seamless process.
Here again, flexibility is key if done within a revocable living trust because if the business is sold or folds, the revocable living trust can always be updated.
In addition to all of the above 7 estate planning benefits, an irrevocable trust may offer some additional advantages the following areas which are further explored in other articles:
- estate tax planning
- asset protection
- gifting to younger generations with control
- pre-Medicaid planning
Powers of Attorney and Using Living Trusts
Most people do NOT understand how powers of attorney impact an estate plan and especially how they can impact a living trust. Most directly, a durable power of attorney can be used to amend a living trust upon a trustmaker’s disability, thereby upending the trustmaker’s entire estate plan.
As a brief overview, there are various types of powers of attorney which are used to empower an individual or business entity to act on behalf of the one giving the power. Durable powers of attorney are unique because they remain effective even if the giver of the power becomes disabled. For this reason, they are used for disability planning.
The important thing to know is that powers of attorney work hand in hand with living trust planning and should be carefully considered for this reason.
DIY Living Trusts [Avoiding Do it Yourself]
For all of the above reasons, and it should be a no brainer by now, you MUST create a living trust agreement that is worth the paper its printed on. If you’re NOT yet there, let me break it down for you…
Boilerplate trusts, i.e Do-It-Yourself Living Trusts, that are purchased for a few bucks on line tend to miss MOST, if not ALL of the above benefits, with the possible exception of #1, avoiding probate.
However, those among the do it yourself estate plan genre of trusts tend to step in it on this point anyway because the guidance offered, and I use the term guidance loosely, often fails to adequately emphasize the importance of trust funding or properly titling your assets into your living trust. If this is missed, your stressed out loved ones might as well use your boilerplate trust for kindling, because it was worth exactly nothing.
A Word About Trust Funding
Trust funding is the process of titling your assets (such as bank accounts, mutual funds, stocks, primary residence) into your trust so that the trust can be successfully used to avoid probate, plan for disability and achieve the various goals discussed above.
A non-funded trust will offer no value to the trustmaker or trust beneficiaries. To be trust property, real estate, bank accounts and other assets must have the name of the trust on their title.
Otherwise, what folks often think is trust property is really their own property that is subject to probate. This is one big reason why DIY trust planning is extremely problematic and should be avoided.
In a time where assets and titles are becoming increasingly complicated, requiring special expertise from experienced lawyers in areas such as digital estate planning, professional insight is critical.
If you’re interested in living trusts or any aspect of living trusts OR estate planning in general, connect with us today.