Image of document cover with living trust & estate planning on white background and a pen belowEstate planning is one of those personal finance topics that few want to discuss. Not having an estate plan in place will cause problems for your heirs at one of the worst possible times – your death. We'll talk more about that shortly. In this post, we will answer the question, what is a living trust. We'll also give you several reasons why you might want to consider making them a part of your estate plan.

I'll start by saying that everyone needs an estate plan. That doesn't mean everyone has one. A 2017 survey says that over half of Americans don't have a will. They say the number is only four in ten. What's even worse, in my opinion, is that only 36% of parents with children under age 18 have a will. Why is that important?

Children under age 18 are minors according to the law. They don't become adults until they reach age 18. One place to name guardians for minor children is the will. If you don't have a will, the state probate laws determine what happens to your kids. You heard that right. You lose the power to decide who takes care of your minor children.

Do I have your attention? Good.

Let's get to the discussion at hand on what is a living trust and why you should consider one.

NOTE: I am not an attorney, nor am I offering any legal advice. The information in the post is provided for educational purposes only. Some information in this post is gleaned from third party sources, and while believed to be reliable, is not independently verified. Before taking any action on anything represented here, you should consult a competent attorney who specializes in estate law in your state. 

Why we avoid estate planning

There are several reasons people avoid taking care of their estate plans. The biggest reason I see is that we are not comfortable with our mortality. We are busy carving out the life we want to live and are not interested in thinking about that life coming to an end.

You might think that attitude is limited to the younger generation (Millennials and Gen Xers). And, for the most part, you'd be right. The same study says that 78 percent of millennials (ages 18-36) and 64 percent of Gen Xers (ages 37-52) do not have a will. That's a frighteningly high number, especially for those who have minor children (see intro).

Studies show that as we age, we get more serious about taking care of things like estate planning and end of life care. According to AARP data, 81% of those age 72 and older and 58% of Boomers, ages 53 – 71, have estate planning documents in place.

Estate planning documents

If you agree with me that everyone needs an estate plan, let's talk about the documents that should be a part of every plan. There are four primary documents. Here's the list and a very brief description of each:

  1. The will – tells the court how you want your property distributed at your death.
  2. A durable power of attorney – gives someone the capability to handle all your financial transactions like bank accounts, to invest, paying bills, etc.
  3. A durable health care power of attorney – gives someone the power to make decisions about your healthcare like what doctors to see, what treatments, what medications, etc.
  4. An advanced directive (living will) – directs caregivers about your wishes for measures taken to preserve your life – things like artificial feeding, breathing, etc.

The fifth document to consider is the living trust.

What is a living trust?

In its most basic terms, a living trust is a document that gives a trustee the power to manage the assets of an individual during their lifetime for the benefit of the beneficiaries.

There are three parties to a living trust.

  • The grantor – the person who owns the property
  • The beneficiaries  – those the grantor designates to receive the property
  • The trustee – the person assigned to manage the property during the grantor's lifetime

The trust is revocable. That means the language of the trust, the property in it, and the trustees can all be changed during the grantor's lifetime. Property can be distributed at death or during the grantor's lifetime or a combination of both.

Unlike a will, which does not own property, a living trust owns the property of the grantor. You are transferring ownership of the property from yourself to the trust. The process of getting the property into the trust is called funding the trust.

The biggest mistake people make with living trusts is not funding them. In other words, they set up the trust without transferring their property to the trust. If there is no property in the trust, it is pretty much a useless document.

Living trust vs. will

The primary benefit of a living trust for most people is in settling estates outside of probate.

Property that passes via a will go through probate court in the state where the property is owned. Probate is the process of transferring and retitling the assets of the estate. The probate court looks at the will and, if valid, instructs the executor to carry out the wishes of the will. After completion, they come back and report to the court that the estate transfer is complete.

Here's is how Legal Zoom describes the probate process:

  1. Your will is filed with the local probate court (and becomes public record)
  2. The executor inventories your property
  3. Your property is appraised
  4. All debts, including death taxes, are paid
  5. The court validates your will
  6. Court costs, attorneys' fees, and executors' fees are paid from your estate
  7. Then, and only then, the remainder of your estate is distributed to your loved ones

Costs and other factors

The costs of going through probate can be steep. In addition to court costs, there are attorney's fees, personal representative fees (your executor/executrix), accounting fees, appraisal fees, and many other costs.

Probate is a public process. In other words, anyone can look at your entire estate via the probate court. There are also time delays. Assets that go through probate via a will can get delayed up to nine months or more. Why? Most states require a public announcement of the death to allow anyone to contest the will. The period is typically around six months.

Publicity, time delays, and costs are three reasons why many prefer the living trust option.

Trusts avoid probate

A properly funded living trust avoids probate. Assets are already titled in the name of the trust, so they avoid going through the retitling process of the probate court. Since you don't own the property and the trust does, the trustee executes the transfer of the ownership via the provisions of the trust.

Since you're not going through probate, your affairs stay private. Privacy is one of the primary reasons people choose a living trust.

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Legal advice

With an estate plan, you will need a competent attorney to help draft your documents. These are legal documents that must be appropriately drafted to avoid costly mistakes and unnecessary time delays. Don't skip this step.

I know the trend these days is to do everything yourself. When it comes to an estate plan, that's not a good idea. Of course, you can get your documents done online. Legal Zoom is a leading online provider of estate planning documents.

Estate planning is more than creating documents. You need someone to walk with your heirs during one of the hardest times of their lives. Losing a spouse, parent, or child is hard enough. Having to deal with someone who doesn't know you or your family during this time brings more heartache to your loved ones. You get what you pay for. Online options may save you money on the documents.

I'd encourage you to ask yourself these questions before deciding. Is my family knowledgeable enough to handle things on their own? Do they want to do this on their own? Will they be emotionally equipped to make good decisions while grieving my loss?

In most cases, the answers to these questions will drive the decision to hire a competent attorney specializing in estate planning.

Creating a living trust

Okay. You'd decided on an attorney and are ready to get started. What are the next steps?

First, set up a meeting with the attorney to plan the provisions of the trust. Remember, your attorney should specialize in this kind of law. They will follow a process and have documents to walk you through the process in a Q & A format.

They will advise you on how to set up your trust. If married, they may recommend a joint trust or two individual trusts to hold the property. I won't get into the pros and cons of each. In my experience, most attorneys advise setting up two trusts.

If that's the case, one trust will be in the husband's name with him as his own trustee. The other gets titled in the wife's name with her as trustee. It's always advisable to name a successor trustee. A successor trustee is one who takes over if the primary trustee becomes incapacitated or dies and can no longer act as trustee.

In most cases, if married, the successor trustee is the spouse. It may also be a trusted family member or a corporate trustee (bank, trust company, etc.). Whichever choice you make, naming these successor trustees assures continuity in the event the primary trustee is unable to serve.

Tax ID

The good news about revocable living trusts is you don't have to apply for a separate tax identification number. The tax ID of each trust is the Social Security of the grantor. There are considerable advantages to this structure.

First, a living trust is a pass-through entity. That means it does not pay taxes as a trust. Like other pass-through entities ( S-Corps, LLCs, etc.), the income generated by the assets in the trust pass through to the grantor's tax return. Why is that good news? The income levels for trusts for the tax brackets are considerably lower. That means trusts get pushed into higher tax brackets much quicker than individuals.

Here's a table to illustrate.

Image of a table showing trust income limits and tax rates

Earning over $12,500 in a taxable puts the trust into the highest marginal tax rate. Passing the income through to the grantor reduces the tax bill considerably.

Having the trust titled in the name of the individual using their tax ID gives the grantor full control over the assets in the trust. The title might look something like this –

John J. Smith, trustee of the John J. Smith living trust dated March 15, 2018.

Remember, for this to work, the trust must be properly funded. Assets must be titled in the name of the trust. Otherwise, it won't work.

Eligible assets

Almost any asset owned can go into a living trust. A partial list includes:

  • bank accounts (checking, savings, CDs)
  • taxable (non-retirement) brokerage  and investment accounts
  • real estate (your home and rental properties)
  • nonqualified annuities (not in IRAs)
  • Life insurance
  • business interests (including LLC and partnership interests)
  • tangible personal property (furniture, computers, collectibles, etc.)

Once these accounts get titled in the name of the trust, the only thing that changes is just that – the title of the owner. You control the assets in the trust just as you did when titled in your (or joint) name. There is no interruption in your ability to do what you normally would do with these assets.

Ineligible assets

Inelibigle assets for titling in a living trust are all retirement accounts. That includes traditional and Roth IRAs, Simple IRAs, SEP IRAs, and all corporate retirement plans, including 401(k), 403(b), 457 plans, and Thrift Savings Plans (federal gov't).

These accounts are individual accounts and cannot be titled in any other name. They have a beneficiary designation. They pass directly to the named beneficiary by operation of law. Because of that, they avoid probate.

The disadvantage of the restriction comes to those who have large amounts of their net worth in retirement accounts. It restricts the ability of married couples to divide the assets between spouses more equally. Unlike a bank, brokerage, and other types of accounts, retirement accounts cannot be transferred to anyone else during the life of the IRA owner. The transfer only happens after death.

The will

Many people incorrectly believe if they have a properly funded living trust with everything titled in its name, they don't need a will.

Though the vast majority of the assets are eligible for placement in a trust, a will makes sure that any assets not titled in the name of the trust, either intentionally or inadvertently, are accounted for. The will in a trust-based estate plan is called a pour-over will. A pour-over will tells the court that any assets not already titled in the name of the trust get transferred (poured over) into the trust at your death.

In most cases, these assets represent a small portion of the estate. Things like personal property, jewelry, and other incidental items are easily forgotten in the planning. In many cases, there are no assets left out of the trust. A pour-over will acts more as a safety mechanism than anything else.

Guardianship of minor children

Another advantage of a living trust is the ability to name guardians for your minor children. Of course, you can name guardians for your children in a will. However, a will gets executed only after your death. If you become incapacitated for any reason and you're still alive, guardian's appointed in the will are not valid.

Your living trust will have language that names guardians for your children and the triggers that would allow the guardianship to start. Another reason to have local counsel to guide you is that each state may have a different definition of incapacity. Having someone knowledgeable in your jurisdiction is essential to get the language right.

Millennials and Gen Xers with young children should strongly consider making a living trust a part of their estate plan for this very reason. It gives you complete control over what happens to your property and, more importantly, your children during your life and after your death.

If you are divorced and have children, having an estate plan is even more critical. If you're remarried and have a blended family, estate planning in a second marriage is vital. You not only have your children to consider, but you now have your spouse's as well. There can be lots of complications in these situations.

Final thoughts

I realize in writing this post, I may have validated your view that estate planning is complicated and something you don't want to deal with right now. I would submit to you that it's only as complicated as you make it. In most cases, the decision on what to do with property and who cares for your minor children is relatively simple. Setting up the proper legal documents is the only way to make sure that happens.

Dealing with the loss of a loved one is hard enough. Not being clear about what you want to happen with your property and not having a plan in place to carry out those wishes puts a tremendous burden on your survivors. I've seen it tear families apart.

Once you get your initial plan in place, going forward, the only thing you have to do is update the plan periodically. You do that when your circumstances change, or when your attorney tells you the laws have changed and you need to update your documents.

Here's the deal. No one gets out of here alive. I'm sure you love your family. You want what's best for them. Take the time to assure part of taking care of them includes a well-designed estate plan. You and they will rest easier knowing you have a plan in place.

Now it's your turn. Do you have an estate plan? If not, what's holding you back? If so, share your experience. We want to hear from you.