What Is A Living Trust?

By January 21, 2017 Estate Planning
Picture of a living trust open on the table

In this post, we’ll answer the question “what is a living trust?” and in the process help you decide if a living trust is right for you. If you are interested in setting up a living trust, contact our Reno estate planning attorney to schedule a free initial consultation.

What is a Living Trust?

There is a lot of confusion surrounding living trusts, and for good reason. Living trusts – and trusts in general – are a very unique concept.

Most people like to think of a trust as a legal entity, similar to a corporation. And many lawyers will even explain trusts using this analogy. Although thinking of a trust this way can make it easier to conceptualize, it’s not technically correct. So, we’re going to take a different approach and give you a true explanation of trust in general, and living trusts in particular.

So, here it is: A trust is a relationship between three parties: the settlor, the trustee, and the beneficiary. Under this relationship, the settlor transfers property to the trustee, who then promises to hold such property on behalf of the beneficiary. There is usually a written agreement to formalize this relationship, but it is not required.

Let’s look at a simple example: Bob has $10,000 that he wants his daughter use for college. He could give the money to her, but he’s afraid she’ll spend it on something else. So, Bob gives the $10,000 his friend Dave with instructions to wait until his daughter is old enough for college, and then use the money to pay for tuition and/or books. Dave agrees to do this for friend Bob.

As simple as it sounds, Bob has just created a trust in which he is the Settlor, Dave is the Trustee, and his daughter is the beneficiary. Even though it would be a good idea for Bob to put the terms of their deal in writing so that Dave can’t just run off with the money, it’s not mandatory. A trust has been created either way.

Living Trust vs Trust

So what’s the difference between a trust and a living trust? Almost nothing. A living trust is just a trust that is created by the settlor while he or she is alive.  So, most trusts are actually “living trusts.” The alternative is called a “testamentary trust,” which is created after death by operation of a Last Will and Testament.

Creation of a Living Trust

A Living trust is relatively easy to create. Unlike a corporation or LLC, you do not have to make any special filings with the government or pay any fees to create a living trust.

It’s really quite simple. To create a living trust, all you have to do is sign and notarize a written legal document and then transfer some of your property into the trust. The legal document creating the trust needs to identify the name of the trust, the person who will serve as initial trustee, and the person or persons who will be the beneficiaries of the trust. Other terms are also typically included, such as rules for the trustee to follow and other specialized terms depending on the goals of the Settlor in setting up the living trust.

We’ll cover how to transfer property into a trust in just a moment.

Me, Myself, and I

An interesting point to make here is that with a living trust, the Settlor, Trustee, and Beneficiary are most often the same person (you). That is, you can transfer your property to yourself as trustee and hold the property for your own benefit. That might seem pretty strange, but it’s 100% legitimate under the law. You are free to add other beneficiaries and trustees as you desire, but the majority of living trusts are set up with the settlor, trustee, and beneficiary all being the same person (or persons in the case of married couples).

How to Transfer Property into a Living Trust

In order to create a living trust, you must transfer property to the trustee. For most living trusts, this means that you will actually be transferring the property to yourself – but as trustee. This might seem pretty silly, but it’s just the way things work. Here’s some more detailed information:

  • Personal property: For personal property that does not have a legal title (jewelry, art work, antiques), the transfer can be done by a simple document that says something to the effect of “I John Doe hereby transfer to John Doe as trustee of the John Doe Living Trust, all of my tangible personal property now owned or acquired by me in the future.”
  • Titled Property: For other types of property that are titled in your name, such as real property, bank accounts, and cars – the transfer is done simply by changing the name of the title to “John Doe, trustee of the John Doe Living Trust.” The procedure for changing the name depends on the type of asset, but it generally the same procedure as if you had sold the property to a third party.
  • Beneficiary Designations: Some types of property are transferred by changing the beneficiary designation instead of the title or ownership. These include life insurance policies, retirement accounts (IRAs, 401(k), etc.), and pension benefits. To transfer the property, you simply change the name of the beneficiary from “John Doe” to “John Doe, trustee of the John Doe Living Trust.”

Just remember that the creation of a living trust is not complete until property is transferred into it. This makes the “funding of the trust” a very important step that unfortunately many people overlook when setting up their living trust on their own.

Benefits of A Living Trust

Many people think a trust is only useful for multi-millionaires who want to set up a “trust fund” for their children. However, this is far from the truth. Trusts can be just as valuable in estate planning for families without millions of dollars as they are for those that do.

Probate Avoidance

The most often cited benefit of a living trust is the ability to avoid probate after your death. In case you don’t know, “probate” is the legal process of distributing your property after you die. Because probate is court supervised, it’s a long, expensive, and drawn out process that can cost thousands of dollars in legal fees and take months to finally complete.

With a living trust, you get to skip to probate. This is because you technically don’t own any property in your name, so there’s no need for the probate process. Instead, the new trustee of your living trust will take care of distributing your property according to the instructions you leave. You can specify who, what, when, and how your property will be given away by the living trust after your death — all of which gets to happen outside of probate and free of court supervision.

Disability

A living trust also provides excellent disability planning. Imagine if you were in a car accident on the way home and ended up in a coma or other incapacitated state, who will take care of your financial affairs, pay bills, and manage your property? Hopefully your spouse has access to these types of things already, but maybe you’re the one in charge of that kind of thing your household. Or worse yet, what if your spouse is in the same accident and is dead or similarly incapacitated. How does your mortgage get paid? Who will pay for your kids school expenses?

With a living trust, it’s easy for the person you appoint as successor trustee to step in and take over control and management of your financial affairs. He or she can access your bank account to pay bills, make sure the kid’s tuition is paid, etc. This avoids the need to spend thousands of dollars in court to have a guardian or conservator appointed and allows your family to manage your affairs without much hassle or interruption.

Inheritance Restrictions

Another benefit of using a living trust is that it allows you to control when your heirs receive their inheritance and how it is spent. As mentioned above, after your death, your assets will continued to be owned by the trustee of your trust. Instead of distributing everything right away, you can easily set up the living trust to hold onto assets like your house, your 401(k), or your life insurance pay-out until your kids (or other heirs) old enough and mature enough receive these assets. You can also have the living trust pay for things like health insurance and college during this time, which can help make sure the assets aren’t squandered on things like luxury cars and partying.

Asset Protection

Unfortunately, a revocable living trust does not provide any level of asset protection. This is a major misconception about living trusts. The property you transfer into a living trust is not protected from creditors. Note that there are other kinds of trusts that can be used to provide asset protection if that’s something you’re interested in doing.

Who Needs A Living Trust?

The honest truth that most estate planning attorneys would never say is that not everyone needs a living trust. The fact is that living trusts are great and offer a lot of benefits, but they are also fairly expensive to set up and the benefits don’t always outweigh costs.

So, here are are some general guidelines for when a living trust is usually a good idea (keep in mind these are just guidelines and you should still seek legal advice if you are considering a living trust):

  • Families with young children, especially if they own a home or other valuable asset (such as a life insurance policy or retirement account). At the very least, parents in this situation should have a Will that creates a testamentary trust for their kids if the unthinkable happens, but generally its better to set up a living trust ahead of time to help save on probate costs and preserve as much of the assets as possible for their children to use when growing up.
  • Families or individuals with more than $200,000 in assets (after subtracting mortgages and other liabilities). This is because estates of more than $200,000 have to go through a more lengthy version of probate that is more expensive and time consuming than probate for smaller estates. For example, an estate of $350,000 would typically incur $10,000 just in attorney’s fees during the probate process. That’s money that could’ve gone to your kids, grandkids, or other family members instead of an attorney’s pocket.

For individuals and families who don’t fit into one of the above categories, other options than a living trust might be preferable. Discuss this decision with an attorney before proceeding one way or the other.