What is a living trust?
The death of a loved one can spark yearslong disputes over assets and cost significant time and money through probate. That’s especially true if they died without naming beneficiaries or choosing someone to manage their estate.
Creating a simple document like a living trust is a comparative bargain when you think about it. Protecting your assets, cutting family disputes off at the head, and avoiding significant probate fees in exchange for a few hours of your time is not only a smart financial decision but a thoughtful one as well.
Learn what a living trust is to determine whether it’s worth adding to your personal estate plans.
What Is a Living Trust?
A living trust, also called an inter vivos trust, is an estate planning document used to manage certain assets both during your life and after your death.
In a living trust, a grantor (also called a settlor) names a trustee to oversee specific assets and manage their affairs. Depending on the type of trust you choose, you can either be both the grantor and trustee or name a trusted individual like an attorney or family member instead.
The primary difference between a living trust and other estate planning documents is that it can also prove useful while you’re alive.
How Living Trusts Work
A living trust works by protecting your assets both during your life and after your death. You create the trust, name a trustee, and then fund your trust by allocating certain assets to it.
You can use the following assets to fund your trust:
- Real estate
- Bank accounts
- Stocks and bonds
- Family heirlooms
You should not or cannot fund your trust with:
- Life insurance policies
- 401(k) or IRA
- Health or medical savings accounts
- Vehicles you use every day
While you’re alive, a living trust allows you to name a trustee to manage your affairs on your behalf. For example, if you want to give someone the ability to run your business without giving up your stake in the company or oversee your investments, you could put them in a living trust.
When you die, your living trust allows your trust assets to bypass the probate process, which is when the courts determine how to distribute your assets as per your will or (if you died without one) the courts’ decision. It’s also a convenient way to name a conservator (financial manager) for your minor children.
Types of Living Trusts
There are two main types of trusts: irrevocable and revocable. Both can help you avoid probate court. But which type you use depends on whether you want to have the option to change or revoke the decisions you made when funding your trust in the future.
Irrevocable Living Trust
An irrevocable trust is set in stone. Although it’s not impossible to change it, it’s both challenging and time-consuming to update once executed. To modify it, the trust’s beneficiaries must consent.
For example, if you named your spouse or children as beneficiaries, they would have to approve any proposed changes before you could implement them.
Even so, it’s still very difficult to make a change to a revocable trust, and it’s typically only done in rare cases.
The grantor and trustee can’t be the same person when a trust is irrevocable. You must name a third party as your trustee.
Many people choose irrevocable living trusts because of the increased protection and tax benefits compared to revocable living trusts. With an irrevocable living trust, your assets bypass estate taxes when you die and can protect assets like your home from creditors.
It also offers you an opportunity to avoid federal estate taxes.
But it’s important to note that estate taxes are only applicable to estates with significant value. For example, the federal estate tax exemption amount for 2022 is $12.06 million. If your estate is valued at less than that amount, it isn’t subject to estate taxes.
Revocable Living Trust
The owner of the trust can update or change a revocable living trust at any time. That means you can add or remove trustees, beneficiaries, and assets as you see fit.
Revocable living trusts let you act as both the grantor and trustee. However, you should name a successor trustee in the event you become incapacitated or die.
A revocable living trust is the most common form of living trust. But it doesn’t provide the same protections as an irrevocable living trust. Because you maintain ownership of the trust during your lifetime, your assets aren’t protected from creditors and your estate is still subject to estate taxes if it surpasses the annual limit.
However, if you don’t need to protect your assets from creditors and your estate’s value is below the federal estate tax threshold, a revocable living trust is still a good option.
Living Trust vs. Living Will
A living trust and a living will are two completely separate legal documents. Where a living trust protects your assets, a living will outlines, defines, and communicates your health care wishes in the event of an emergency or incapacity.
But you should create both documents along with a last will and testament, power of attorney, and letter of instruction. This type of well-rounded and all-encompassing estate plan covers your health care wishes, preferred beneficiaries (including charities), assets, and debts, among other things.
If you aren’t sure which estate planning documents are right for you or need help with your estate plans, seek legal advice from an estate planning attorney.
Advantages and Disadvantages of Living Trusts
Both revocable and irrevocable trusts come with pros and cons. Before deciding to move forward, it’s crucial to weigh the risks and rewards to determine which, if either, living trust document is suitable.
Advantages of Living Trusts
There are many reasons people create trusts as part of their estate plans. They provide various benefits, from protecting your assets to naming caregivers for your minor children.
- Trusts Help You Avoid Probate. Because the assets in your trust are either already in your trustee’s name or pass to your successor trustee upon your death, they typically bypass probate court, saving your estate and beneficiaries time, money, and stress.
- Trusts Offer Inheritance Requirements. Because trusts bypass probate, they aren’t subject to the courts’ review, meaning you have more control over when and how your assets go to your beneficiaries.
- Trusts Name Conservators for Minors. Trusts allow you to name a conservator to manage your children’s inherited assets until they come of age. For example, a financial manager could oversee investment and business interests on their behalf.
- Trusts Are Useful in the Event of Incapacitation. Trusts work both during your life and after death. For example, if you become temporarily or permanently incapacitated, your trust remains in effect.
Disadvantages of Living Trusts
Trusts aren’t a good option for everyone, though. Depending on your estate planning goals, assets, and what you want to use a trust for, they can negatively impact your estate plans and daily life.
- Irrevocable Trusts Are Hard to Change. When you make an irrevocable living trust, you must sign over any assets to a separate trustee. And it can be virtually impossible to get them back. That makes it difficult to do things like sell your house, access your financial accounts, and make changes to your assets.
- You Have to Have a Good Trustee. You shouldn’t let just anyone manage your trust. Although your trustee has a fiduciary duty (legal obligation) to make decisions and manage your affairs in your best interests, someone with limited financial literacy or experience may not be suited to act on your behalf.
- Changing a Trust Is Difficult and Costly. If you create an irrevocable living trust, it’s nearly impossible to change it. Doing so is a long and costly process. And while it’s much easier to change a revocable living trust, you have to pay each time you want to update it.
- You May Have to Sign Over Your Assets. If you name a trustee other than yourself or create an irrevocable trust, you must sign over any assets within the trust. Getting these assets back into your name is extremely difficult.
Do You Need a Living Trust?
Whether you need a living trust depends on how you want your assets managed after you die and whether you anticipate having to pay federal estate taxes or go through probate.
However, very few estates are subject to taxes based on the annual estate tax threshold, and you can’t place all your assets in a living trust, meaning they may still be subject to probate.
To determine whether a living trust is right for you, ask yourself the following questions:
- Will my estate be subject to federal estate taxes?
- Which of my assets are subject to probate?
- Do I have any other estate planning documents, like a will or power of attorney?
- What are my estate planning goals? For example, do I want to restrict my beneficiaries, make health care decisions, or name someone to make decisions for me?
Based on these questions, you can determine whether you should create a living trust or whether other estate planning documents are better suited to your situation. If you’re still not sure, consult with an attorney.
How to Set Up a Living Trust
DIY services typically only offer revocable living trusts. If you need an irrevocable living trust, have a complicated estate, or want to put specific limitations on the beneficiaries, speak to an estate planning attorney.
Living Trust FAQs
Living trusts can be complicated. If you’re still not sure whether a trust is right for you, the answers to these frequently asked questions can help you make an informed decision.
How Much Does a Living Trust Cost?
The cost of setting up a living trust varies greatly depending on whether you use a DIY service or attorney and the type of trust you need. Funding the trust can also come with additional costs, such as fees to transfer your financial accounts and deeds into your trustee’s name.
You can expect to pay anywhere from $100 to $2,000 to set up a basic trust. But the cost increases based on its complexity and whether you need to update or change it.
How Is a Living Trust Handled in Probate?
When you die, depending on whether you had a revocable or irrevocable trust, your assets either automatically transfer to your successor trustee or were already in their name.
That means they’re not subject to the probate process.
How Does a Living Trust Affect Estate Taxes?
The assets in your trust aren’t technically part of your estate since they belong to someone else, so they’re not subject to estate taxes. However, estate taxes only affect a small percentage of individuals, anyway.
Does a Living Trust Protect My Property From Creditors?
An irrevocable living trust may protect your home or other property from creditors because they are in someone else’s name. However, that also makes it difficult to sell them. You shouldn’t put property in your irrevocable living trust unless you understand all the potential repercussions.
A revocable living trust doesn’t protect your property from creditors since you technically still own the assets within it.
Do I Need a Will if I Have a Living Trust?
Yes, you should still create a last will and testament even if you have a living trust.
Unlike a trust, you can use a will to:
- Name a guardian to see to the daily care of any minor children
- Forgive any debts owed to you at the time of your death
- Cover any property and belongings that aren’t part of the trust
- Create a trust upon your death, known as a testamentary trust (as opposed to an inter vivos or living trust that you create while you’re alive)
People often associate trusts with those who have significant wealth. But they aren’t just for celebrities and billionaire entrepreneurs. A trust provides benefits to just about anyone who wants to use it to bypass probate, set requirements for their beneficiaries, or name a conservator to oversee their finances until their heirs come of age.
If you decide to create a living trust, think carefully about whether it should be revocable or irrevocable, and be sure to support it with other important estate planning documents. Update your estate planning documents, including your revocable living trust, every so often to ensure it’s relevant and reflective of your current assets and desired beneficiaries.