What is a Living Trust?

A living trust is like a safe with a key...

You put your assets in the safe and give the key to someone you deeply trust, aka the trustee. While you’re still alive, you tell that person who should get each item when you pass away. When the time comes, the trustee will use your key to open your safe and hand out your assets to the people you named. Similarly, in a living trust, the trustee gets control of the grantor’s assets and hands them out to beneficiaries upon their death.

A living trust is a type of legal arrangement often used for estate planning that helps family members and inheritors avoid the lengthy probate process. Living trusts can also be used to manage the assets of a minor, a disabled person, or an older person who can’t take full responsibility for themselves.

Generally, when someone passes away, a portion of their assets, such as bank accounts and investments, may be held up in probate before being passed to inheritors. These are called probate assets. Non-probate assets, such as universal life insurance policies or houses in a joint tenancy, are disbursed directly to beneficiaries.

During probate, the state examines and validates a deceased person’s will, an accounting of their assets and debts, and disburses assets to their rightful inheritors and creditors. This process can take a long time, and it can be expensive, too, leaving grieving family members with a lot of extra stress.

That’s where living trusts come in. A living trust transfers assets to a trust so that they don’t have to go through probate. Instead, a specified trustee disburses the assets to beneficiaries.

A living trust can streamline the management of assets after your death. Without a living trust, many assets will go through probate, a lengthy process during which the state validates your will and assesses outstanding debts. Put simply, the probate process is no fun for anyone, especially right after the death of a loved one. A living trust can spare your family time, money, and stress during a difficult period. Plus, living trusts offer more privacy — Living wills are part of the public record, and probate proceedings are public as well.

When you have a living trust, all the assets covered by the trust are managed by one or more appointed trustees. Upon your death, the trustee or trustees will transfer the assets to the proper beneficiaries. Since you’ve made it clear that you trust the trustee’s interpretation of your will and desires, the assets don’t need to go through probate before being disbursed.

Plus, depending on the type of trust you establish, you may get tax benefits or protection from creditors. If you form an irrevocable trust, you’ll transfer ownership of the assets to the trust while you’re still alive. Since you no longer have ownership of the assets, they aren’t part of your estate, and there won’t be estate taxes on them upon your death. An irrevocable trust also means that lawsuits and creditors can no longer get to “your” assets (they’re not yours anymore), which protects your beneficiaries.

But living trusts aren’t just useful in the case of death. Trusts can be established to help manage the assets of a minor or even your own assets if you become unable to manage them due to age or illness.

Though the names sound similar, these are two completely different things.

A living trust generally deals with the management of your assets.

A living will, also known as an advance directive, is a legal document to be used if you are incapacitated and can’t communicate your wishes as to the types of medical care you do or do not want, including life-sustaining treatment, such as assisted breathing or tube feeding.

There are two types of living trusts: revocable and irrevocable living trusts.

In a revocable trust, the person making the trust (grantor) retains absolute control over and ownership of all their assets. When the trust is established, the grantor can appoint themselves as a trustee and can make changes to any provisions covered by the trust. They can even terminate the trust and reclaim their assets. Making changes to the trust isn’t always easy (there may be a lot of paperwork depending on how significant the changes are), but it’s doable. Upon the grantor’s death, a revocable trust is converted into an irrevocable trust.

Revocable trusts are often used to protect the grantor’s assets if they’re incapacitated and can no longer make decisions (if they’re in a vegetative state, for example). In a revocable trust, your assets are still considered to be your property, so they’re subject to estate and income taxes, and they’re still liable to lawsuits and creditors.

In an irrevocable living trust, ownership of the assets in question gets transferred to the trust itself. The grantor cannot name themselves as a trustee. The provisions of an irrevocable living trust can only be altered under specific circumstances, and in some cases will require judicial approval. Even though it’s possible to make changes, an irrevocable trust does not allow you to reclaim your assets.

In exchange for surrendering control, grantors get a few benefits. Since they no longer have ownership of the assets, the assets won’t be taxed as part of their estate. They also won’t factor into the grantor’s net worth, so the assets won’t affect eligibility for government programs like Medicare. Furthermore, the assets are protected against a lawsuit and seizure by creditors.

Living trusts start with the creation of a trust instrument, a legal document that sets out the rules and provisions of the trust. The grantor creates this document and then transfers the title of the desired assets to the trust.

In a revocable living trust, the grantor will specify one or more trustees (often including themself), who will have the power to manage the assets. The grantor will also name one or more beneficiaries, who can receive assets from the trust. Upon the grantor’s death, the trust will convert into an irrevocable trust, and the assets will be disbursed to beneficiaries.

In an irrevocable living trust, the grantor will specify one or more trustees to manage their assets, but they cannot name themselves as a trustee. The assets in the trust are no longer considered to be the grantor’s property, and the grantor can only change provisions with the consent of the beneficiaries and/or a judge.

Revocable living trusts don’t have any effect on taxation. Any income generated by the assets in the trust are still subject to income tax, and the property is subject to the same estate taxes as if the trust didn’t exist.

Irrevocable trusts, however, have several tax benefits. Since the property is no longer owned by the grantor, the grantor does not have to pay taxes on it. The trust itself is responsible for the taxes, and the beneficiaries will usually avoid estate and inheritance taxes.

However, assets transferred to an irrevocable trust can be subject to gift taxes. Gift taxes apply when the grantor gives up complete control of an asset to the beneficiary — The grantor is responsible for the gift tax.

But gift taxes have exclusions of up to $15,000 for each recipient per year and are also subject to the $11.58 million lifetime estate and gift tax exclusion as of 2020. In order for a gift to qualify for the exclusion, the recipient or beneficiary must be able use the gift in the present rather than the future (present interest).

According to Crummey v. Commissioner, assets transferred to an irrevocable living trust can qualify for the exclusion if the beneficiary is notified of their right to withdraw the asset transferred to the trust for a limited period of time. In this way, grantors may avoid both estate and gift taxes by using an irrevocable living trust.

Gift taxes do not apply to gifts:

• That are less than the exclusion for the year
• Given from one spouse to another if the spouse is a US citizen
• Used for tuition or medical expenses
• Given to political organizations

There are several advantages to living trusts:

• Avoid probate: Assets that are properly transferred into a trust do not need to go through probate.
• Tax breaks: If you place your assets in an irrevocable trust, you generally will not need to pay income or estate tax on them because the trust itself is responsible for the taxes. And you can take advantage of gift tax exclusions if you follow proper protocol.
• Protection against creditors and lawsuits: Assets in an irrevocable trust are no longer your property, so they generally cannot be taken by your creditors or subject to a lawsuit against you.
• Privacy: The contents of a will are publicly disclosed upon death, and probate is a public proceeding, but a living trust remains private.
• Provides help if you become incapacitated: If you become unable to manage your assets due to illness or age, the trustee of a living trust can manage them for you.

Disadvantages of living trusts include:

• Loss of ownership: If you set up an irrevocable living trust, you will lose ownership and control over your assets.
• Usually requires legal counsel: Hiring an attorney to write up a living trust agreement may be an expensive endeavor if you don’t have a lot of disposable income.

Whether one should make a will or living trust depends on that person’s personal situation. The primary benefit of a living trust is that the assets it covers will not go into probate upon the death of the grantor, which provides extra privacy and can save time and money for the beneficiaries. It can also be used in case the grantor becomes incapacitated, or to manage a minor’s finances.

However, living trusts are not as simple to make as wills (they usually require the aid of an attorney). Plus, living trusts cannot specify guardians for children. To do that, one needs a will.

This article contains general estate planning concepts and not legal advice. Please consult with your attorney before entering into any legal agreements. Additionally, Robinhood does not provide tax advice. For specific tax related questions, you should consult a tax professional.