The Ins and Outs of a Living Trust

The use of living trusts has exploded in recent years. If you’re looking for an easy and affordable approach to managing your estate, you may want to consider a living trust.

How they work

Each state has its own set of rules for creating a living trust. In general, you sign a document establishing a trust to keep the property for the benefit of yourself, your family, or anybody else you choose. The critical use for a living trust is to avoid probate – usually required when an estate is left through a will – which saves your estate time and money. And, unlike wills, living trusts are typically kept confidential, ensuring that no one knows how the trust’s assets were allocated.

Some trust declarations include the principal assets (house, investments) that you’re placing in trust; others refer to a separate document, a schedule, that lists the specific property in the trust. In the trust agreement, you may transfer your property to the trustee, from whom you can add and deduct property as you see fit. You’ll need to transfer ownership of any property you put into the trust — deeds, brokerage accounts, and bank accounts — from your name to the trust’s name (e.g., The Johnny Appleseed Trust).

You must remember to sign transactions as “Johnny Appleseed, Trustee,” rather than simply your name if you appoint yourself the trustee. When you transfer property to a living trust, the trust becomes the owner, which is why you must change the title from your name to the trust. However, you maintain the right to use and enjoy the property, and since you do, tax authorities see the trust’s holdings as belonging to you, the grantor. If you get income from the assets, you must record the trust’s income on your tax return.

Although the Internal Revenue Service does not need a separate income tax statement if the grantor and trustee are the same people, the trust files one. It’s a good idea to apply for an employer identification number for the trust with the Internal Revenue Service (IRS). You have the option of appointing anybody as a trustee. You can also set a replacement trustee (also known as a successor trustee) to take over if the original trustee dies or becomes incapacitated.

Because you can modify the terms of the trust, the trustee, and the property in the trust at any time, whether or not you’re the trustee, you maintain the right to manage your property in a revocable living trust. When you pass away, the property is distributed according to the conditions of the trust by your alternative trustee. Your alternative trustee is usually your surviving spouse or an adult child, but if you’re willing to pay their costs, you may pick a bank or trust business.

The trust must be integrated into your overall estate strategy. The executor of your will is responsible for paying income and inheritance taxes, as well as other probate charges. Still, if too much of the estate assets are held in trust, the executor may not be able to make these payments. Thus the trustee (and successor) should be granted the authority to make these payments from trust assets.

What living trusts won’t do

Living trusts are estate planning tools. But keep in mind:

1. They will not assist you in avoiding taxes. A properly designed estate plan will save more income and estate taxes than a revocable living trust. The property is included in your tax bill. In the same way that a will requires your successor trustee to pay income taxes created by trust property and owing at your death, your successor trustee must pay income taxes generated by trust property and payable at your end. Your successor trustee must also submit the necessary tax returns if the estate is significant enough to attract state and federal estate or inheritance taxes. Because of these and other responsibilities, the cost of managing certain living trust estates can be almost as costly as standard estate management. A revocable living trust will not save taxes on its own.
2. They will not render a will obsolete. You’ll still need a will to handle any assets you don’t transfer to the trust or acquire soon before you die. If you have minor children, you will very certainly need a will to name a guardian for them.

Living trusts can last for a long time after you’ve passed away. It’s possible to choose a trustee who will make regular donations to the trust’s beneficiaries, like your grandchildren or great-grandchildren. Living trusts, like wills, provide you with a lot of options when it comes to transferring your assets.

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