A living trust gives your estate direction, ensuring your loved ones handle it as you wish. Trusts can also help seamlessly pass the trust’s assets to your heirs by avoiding probate court. While trusts seem confusing and complex, they aren’t as complicated as they sound. With the right help, you, too, can open a trust and protect your assets, and this guide will give you a crash course on living trusts as an estate planning tool.
The basics of a living trust
If you’re wondering, “How does a living trust work?” a trust is a legal document that holds your assets, such as real estate, cars, and investments. It helps protect your assets during your lifetime and beyond. The trust takes ownership of the property, but you generally still retain control over your assets.
Your trust documents also help outline your wishes for your assets after you pass away. You can use the trust to specify exactly how you want your assets distributed.
When you die, your trustee is responsible for distributing the assets to your named beneficiaries according to the terms of the trust.
Two types of living trusts
You have two options when setting up a living trust agreement: a revocable or an irrevocable living trust. Let’s explore how each type works and why you might choose one over the other.
Irrevocable living trust
An irrevocable living trust is a sort of trust that can’t be changed.
Even as grantor or trustee of the trust, you cannot change or terminate it—without exemption. Once an irrevocable trust is in place, you give up the ability to modify it.
Thus, irrevocable trusts are less common for obvious reasons.
Why people opt for irrevocable trusts over a revocable trusts
But why would someone opt for an irrevocable trust over a revocable one?
There are three main reasons:
- You want to minimize estate taxes through a life insurance trust or annuity trust.
- You have a disability and need to shelter assets and income to avoid losing federal benefits.
- You want to protect your assets from creditors.
Revocable living trust
The revocable living trust gives you—as the grantor and named trustee—the power to make changes while the trust is in effect.
A revocable trust is the most common type because it allows you to maintain control of your assets. As trustee, you can amend trust directives as needed, including dissolving the trust if necessary.
Just know making changes or canceling a revocable trust isn’t easy. You’ll still have to deal with a ton of paperwork and jump through administrative hoops. Still, it is technically possible to change or cancel a revocable trust.
How does a living trust work?
When you open a trust, you transfer your assets into the trust. You no longer ‘own’ the assets once you put them in the trust – the trust owns them.
However, you can retain control of your assets by naming yourself a trustee. Most people also name a successor trustee should they die or have the incapacity to manage the trust.
The successor trustee’s job is to act on your behalf and distribute the assets per your instructions when you die. You can also name specific conditions the beneficiaries must meet before receiving their inheritance.
For example, you might require that your children reach a certain age or complete college to receive funds.
Setting up a living trust: How to get started
Many people skip this because they’re unsure how to get started. Although the process is tedious, it’s often not overly complicated.
Your trust can be ready to go in six steps:
- Contacting estate attorneys
- Selecting assets for your trust
- Picking a successor trustee
- Naming beneficiaries
- Signing the trust agreement
- Transferring assets into trust ownership
1. Contact an estate planning attorney
Can you set up a living trust by yourself? Technically, yes.
However, your trust needs to follow certain state laws and regulations regarding trusts. Without extensive legal knowledge, setting up a trust on your own could be a bad idea.
Instead, get in touch with an estate planning attorney who specializes in living trusts. An attorney may come with a larger price tag than drafting the trust on your own, but you’ll know it’s done right.
In addition, attorneys can provide valuable insight into the formation of your trust. Your attorney will make clear to you the potential impact of setting up your trust a certain way. They’ll also help you work through other aspects of your estate planning checklist.
For example, your attorney can help you determine if a revocable or irrevocable trust makes the most sense for your needs.
2. Determine the assets for your trust
The next step to creating your trust is to determine what assets you want in the trust. Common assets you might put into your trust include:
- Real estate, such as real estate investments or your home
- Financial accounts like non-active bank accounts or non-retirement brokerage accounts
- Non-qualified Annuities
- Life insurance (read about the importance of life insurance)
- High-value personal items such as fine art or expensive jewelry
You shouldn’t put retirement accounts in your trust. Adding retirement accounts to a trust requires withdrawing the funds from the accounts.
A withdrawal will likely result in income taxes on the funds. The better option is to name your trust as a beneficiary on the retirement account.
3. Choose a successor trustee
Your successor trustee is the individual who takes over as trustee after your death. Choosing a successor is an important step because this person will eventually take control of your assets through the trust.
Your family situation will play a big role in your successor trustee.
For example, parents of minor children generally choose their preferred guardians. If the parent dies while the children are still young, the guardian gets access to assets or funds to help cover the living expenses of the children.
4. Name your beneficiaries
The beneficiaries of your trust are those who will benefit or receive the assets owned by the trust.
You can choose any beneficiaries you want, including friends, family, or even charities. Think about who you want your assets to go to, especially if you’re funding an irrevocable trust.
Many people list their children as beneficiaries to help build generational wealth.
5. Sign the living trust document
Signing is the easiest part of the process.
Once your lawyer has drafted the trust documents, you can review them and make changes as needed. When you’re ready, you’ll sign the trust in the presence of a notary public. Your attorney or one of their associates will likely be licensed as a notary.
6. Transfer assets and fund the trust
Funding the trust isn’t as simple as making a bank transfer or signing a form. You must rename all assets in the trust’s name to officially put them in the trust.
This process generally requires a fair amount of paperwork and might take a while to complete. (Learning how to declutter paperwork prior to this can be helpful!)
Say you want to put your house in your trust, for example. You’ll need to make the trust the new owner by changing the property’s title. Doing this requires signing a new deed for the trust property.
Additionally, you’ll need to notify your city or county of the change, which could require a small title transfer fee.
Pros of a living trust
A living trust is one of the most useful estate planning tools to protect your assets. Let’s look at some of the benefits.
Avoids probate
If you die without a trust, your estate goes into probate. The probate process is the legal process of reading and executing a will. The probate process also appoints an executor of your estate to distribute your assets.
Probate can delay when your beneficiaries receive their inheritance. It can also be time-consuming for the executor, who must oversee everything.
A living will, however, bypasses the probate process.
Avoids anyone contesting your wishes
Even the most close-knit families can get ugly when inheritance is involved, and family financial problems could cause concerns. Challenging a will is common, but a trust lowers the risk.
Contesting a will involves petitioning the probate court. Trusts skip probate, so it’s more difficult to contest. Challengers of a trust must prove you were not of sound mind—or were coerced—into setting up the trust and funding it, in addition to a couple of other reasons, claims Smart Asset.
Trusts create privacy
The probate process becomes part of the public record. That means anyone could see how much money you’re giving to heirs or what assets you have to give.
On the other hand, trusts aren’t public records. No one will know how much you left to your beneficiaries. Taking this route also reduces the risk of someone targeting your family or loved ones based on their inheritance.
Cons of a living trust
There are plenty of reasons a living trust is a good idea, but are there downsides?
As with most things, yes, there are drawbacks.
Trusts are costly
There’s no way around it: a trust is going to cost a chunk of change to set up. You’ll need to hire an estate lawyer to help you draft and fund your trust. You might also have to pay title transfer fees to move assets into your trust’s name.
All in all, you can expect to pay between $1500-2500 in the USA, according to Contracts Counsel, to draft a living trust. The more complicated your needs or assets, the more you may have to pay.
Inconvenient to make changes
A revocable living trust may offer some flexibility, but it’s still difficult—and likely expensive—to make changes. You’ll need to contact your lawyer to sell, add, or modify assets in the trust.
Even something like refinancing your home requires your attorney to remove the asset from the trust before you can make changes to your mortgage. Then, you’ll also have to pay your attorney to re-title the asset back into the trust.
Administrative work is hefty
Setting up a trust takes a lot of consideration. You have to determine what assets to put into the trust, who will be your successor trustee, and who will be your beneficiaries.
Additionally, putting your assets into a trust means renaming the assets. For many things like your house, bank accounts, and investments, it means a lot of paperwork and potentially some fees.
Expert tip: Consider a joint trust if you’re married
Married couples can set up an individual living trust for each spouse or create a joint trust with shared assets.
Joint trusts are less complicated to set up and could make it easier for a surviving spouse to access assets.
When you are putting your financial goals and financial affairs in order, make sure to consider this simpler approach.
Who are living trusts best for?
A living trust is best for anyone who wants control over their estate. It’s not just about managing who receives your inheritance upon your death, but rather managing your estate to avoid probate and put a 3rd party in charge of certain assets until all beneficiaries satisfy any conditions you set.
Suppose you’re concerned about your estate going through probate. If your estate goes through probate, it may take more time for beneficiaries to receive their inheritance. Not to mention that anyone could potentially challenge your estate.
On the other hand, a living trust could prevent your estate from going to probate at all.
Living will and trust: What’s the difference?
A living will and trust both have to do with your estate, but the similarities end there. The importance of a will should not be overlooked, but a living trust is equally important.
Here’s what you must know about the differences between a living will and trust:
A last will goes into effect when you die
A will doesn’t control your assets when you’re alive, even if you’re unable to make your own decisions. A living trust, on the other hand, manages your assets from the moment you open and fund the trust.
You are the trustee while you’re alive (if you choose to be), and your successor trustee takes over when you cannot manage your estate.
A will typically goes through probate
Even a will with specific instructions for distributing assets will likely go through probate. The probate process typically holds up the distribution of the estate. Probate also usually has court fees and costs associated with the process.
A living trust doesn’t have to go through the probate process.
A living will is a public record, whereas a trust is not
Since the probate process is public, your will is public. This lets anyone see what you’re leaving to your beneficiaries.
A living trust is a completely private agreement. Anyone not listed in the trust would not have access to the documents.
What is the point of a living trust?
The point of a living trust is to improve the efficiency of distributing your assets after your death. Trusts avoid probate, making it easier for your trustee to distribute assets to your beneficiaries according to your wishes.
What is the downside to a living trust?
The biggest downside of a living trust is the cost and the paperwork involved in creating it. Complicated trusts may cost several thousands of dollars to create. You also have to go through the paperwork and time to retitle your assets in the trust’s name.
What is the primary purpose of a living trust?
The primary purpose of a trust is to create a smooth distribution of your assets upon your death.
Additionally, trusts give you the ability to specify how assets are to be used.
For example, you might require your minor children to turn a certain age before they receive ownership of assets in the trust. It helps to teach financial literacy for kids to your children so they have a good foundation for handling money in the future.
Articles related to trusts and estate planning
If you now have a better understanding of trusts and what they do, read these articles next for more information!
Next steps: Create your own living trust
A living trust helps organize and protect your estate. Understanding the process of funding and managing the trust is important. Having a trust ensures you can determine what happens with your estate when you’re alive and have peace of mind that your successor will handle it how you planned upon your passing.
Make sure you have a good financial planning process for each part of your finances, including retirement and investing. Also, consider other important aspects of your finances that will help you prepare for the future, such as saving an emergency fund.