When most people read about Trusts, they think it’s only for the wealthy. This is not true. Trusts can be used by any adult with inheritable assets to ensure distribution of those assets upon that person’s demise. All trusts are essentially legal arrangements which are set up using properly drafted documentation and adhering to legal formalities. There are many types of trusts, each of which serves a specific purpose. Of these, the Living Trust is perhaps the most useful and impactful for the typical adult or married couple.
Key Advantage of Living Trusts – Sparing Loved Ones from the Probate Process
A Living Trust is used to hold assets owned by an individual (“grantor”) who intends that such assets pass on to his/her chosen beneficiaries upon death. It is created by the grantor during her lifetime (hence the word “Living”). The advantage of Living Trusts is that there is no need to go to Probate Court to obtain judicial approval of the distribution of assets (which is required when that distribution is governed by a Will). If the Trust – not you – owns the assets (i.e. holds title thereof), then there is nothing (i.e. no “estate”) to probate. This simple but powerful concept of ownership is what removes the need for probate.
There are other advantages to Living Trusts: unlike Wills, they are not of public record since there is no Probate. Also, in the case of a Will, assets are distributed to beneficiaries once the Will is probated. Typically, the executor of a Will submits it to Probate court upon the death of the will-maker. There is therefore a timeline for distribution determined by the date of demise. By contrast, the grantor of a Living Trust can specify exactly when a beneficiary receives the assets, and this can be many years after the demise of the grantor. Death sets the Will into motion, bringing its operation into existence. A Living Will which operates during the maker/grantor’s lifetime starts to operate the moment it is legally created. A Living Trust terminates when all assets it holds are distributed. If there are no assets in a trust, it ceases to exist.
Revocable vs. Irrevocable – Control Of and Access to Assets During Lifetime
A Revocable Living Trust (RLT) is one type of Living Trust. Oftentimes, when someone talks about a Living Trust, what they really mean is an RLT. An RLT is often contrasted with an Irrevocable Living Trust. The the trust during her lifetime, and even use such assets through the Trust. This is possible because in an RLT, the grantor is also the beneficiary of the trust. In an RLT, the grantor-beneficiary can draw on both principal and income on any financial assets within the Trust. She can also access income generated by any real estate property, and upon sale of such property, receive the gains of the sale through the Trust. This is not possible where the Living Trust is irrevocable. The grantor is locked into her decisions and choices upon creation of the Irrevocable Living Trust; she has no access to or control over trust assets.
Titling Assets into the RLT – Be Vigilant About Transfers
Trusts can’t exist unless they contain something. Which means that your RLT must be funded (the legal term for moving assets into the Trust). If an asset is not in your RLT at the time of your passing, it will not be distributed according to instructions you’ve set out in the Trust.
Not all assets can be moved into a Living Trust. For example, if you own property as a joint owner with another person or entity, you can’t title this asset.
Taxes on the RLT – Goes on Personal Income Tax Filing
During your lifetime, your RLT still has to pay taxes on any assets for which taxes are due under IRS rules. Note that we’re not talking about inheritance or estate tax here, but income and capital gains taxation. Be sure to consult your tax advisors on the specific IR requirements that affect your RLT.
The other advantage of an RLT is that the grantor can declare all income and capital gains of the Trust on her own personal tax filing. For IRS purposes, there is no distinction between the RLT and the Grantor.
Formalities for RLT
Like all legal documents your Trust document has to be properly worded to reflect its trust character. This means that any court of law would deem the document to properly set up the RLT, and that it can properly operate as an RLT. You can certainly draw up your own trust documents, but be careful about understanding the law that regulates RLTs; misunderstanding them can lead to big gaps in your trust, and thereby disabling them.
The other thing to note is that you should have a Successor Trustee for your RLT. This is important because if you become incapacitated (as defined by law), no one – not even your spouse – can have access to the assets and whatever income that they generate.
Impact of Incapacity on RLTs – Successor Trustee steps in
Should the Grantor of an RLT be incapacitated, the legal consequence is that the person who controls and benefits from the Trust is no longer legally able to direct/manage the Trust. This is why it’s important that when you set up your RLT, you pick a successor grantor. In the case of married or partnered couples, you can be each other’s successor grantor (or even be co-grantors in one single trust).
Assets Left Outside the RLT – The Pour-Over Will ties up loose ends
If at your time of passing, there are assets which are not titled in the RLT, they can be dealt with via what we call a “Pour-Over” Will. A Pour-Over Will still has to be probated, but given that most assets for inheritance will be dealt with via the RLT outside the Probate Court process, probating the Pour-Over
Where the RLT fits in an Overall Estate Plan
Is it possible to have other Trusts (e.g. Charitable Trust or Trust for Minor/Special Needs Children)? Yes. Trusts operate separately, even if you have a more than one trust in your overall estate plan. It is important, however, not to have duplication of counter-effects. For example, if you have given one person Power of Attorney (POA) for your financial assets, but also have an RLT with a co-trustee for the same assets, which person would prevail in terms of access to your assets? The answer is simple – when title is properly moved to an RLT, only the trustee(s) of the RLT can deal with them legitimately. The person you’ve chosen to have a POA for your financial assets will still have the power but over assets outside such power.
Remember too that RLT deals only with your assets, not your physical or mental well-being. You should have Advanced Directives (e.g. Living Will or Health Care Proxy) in your estate plan. Advanced Directives contain instructions to your medical care providers or health care proxy to make decisions about your medical treatment when you are unable to do so yourself (when you are mentally or physically incapacitated). My estate planning blog covers Advanced Directives, and I highly recommend you take a look.
Important for Parents – You Still Need A Will
Married or partnered couples can be co-trustees in an RLT (ditto for any other two people who trust each other e.g. siblings). Alternatively, they can be each other’s successor trustee in their respective RLTs. For persons with minor children, a Will is still necessary as it’s the only estate planning document in which parents can lay out who is to be the Legal Guardian in the event the children lose their parents. The same provision, however carefully laid out in a Living Trust, has no effect. You can read more about Wills and Guardianship of minor children in my estate planning blog. It is not unusual for parents with minor children to have both a Living Trust and A Will. In fact, this is the typical set up for most of my married clients with minor children.
To Sum Up
In short, Living Trusts are an estate planning vehicle for those who wish to avoid Probate, which involves much more time and lawyer’s fees. Both of which can cause additional hardship to loved ones who are beneficiaries. Also, Probate is a matter of public record; Trusts are private and not subject to public scrutiny without a court order.
It’s important that you have a realistic understanding of the Probate process (note: you can read a detailed piece about Probate on my Estate Planning blog). Most people think that because they aren’t super-rich, and have only a few key assets (e.g. house, bank account, car), they won’t face a laborious Probate process. While there is some truth to this, remember that even if the actual court hearing itself will be quite straightforward (provided your Will is properly drafted and witnesses), it still takes time to get a court date, file the proper paperwork and prepare for the hearing. Of these, just getting a court date in a high-population state like New York can push the distribution of assets many months into the future. In a situation where your loved ones need access to your assets quickly to maintain their lifestyle and meet their needs, you really don’t want to take the chance of more delay.
Setting up a Living Trust is more complex and time-consuming (and therefore more costly in terms of legal fees) than setting up a Will. It simply requires more planning and paperwork (especially the transfer of titles of assets to the Trust). That said, if you wish for your loved ones to avoid Probate and to maintain privacy, an RLT is probably the better option. It’s either you spend the time and money inter vivos, or leave your beneficiaries to spend that time and money later on, when they can’t afford to wait and do not have the funds they need.