With so many misconceptions around trusts, it’s easy to understand the confusion about the benefits of a revocable living trust. A living trust (also called a revocable trust or revocable living trust) can be beneficial to a much broader group of Americans than most people expect. During life, a living trust is essentially an extension of yourself (and a spouse if you decide on a joint trust). There are no tax benefits during life nor are there any adverse tax implications. However, at death, a living trust can provide two key benefits compared to owning assets not held in trust.
What happens to my assets after I die?
Before diving into a discussion on the benefits of living trusts, it’s important to first understand what happens to different types of assets after someone dies. Here’s a quick, high-level summary:
- Beneficiary designation: Certain types of assets will pass onto the beneficiaries you name during life. Common types of assets that will pass via beneficiary designation include retirement accounts, life insurance, and some pensions and annuities.
- Joint owner: Assets that are owned jointly (outside of trust) will become the property of the survivor(s) after the death of a joint owner. The most common examples of joint assets are real estate, bank and brokerage accounts.
- Individual ownership: Assets owned individually often mirror the examples above, though it isn’t possible to own every type of asset jointly. If an asset is held individually, it’s much more likely to become a probate asset. Bank and brokerage accounts permit transfer-on-death (TOD) and payable-on-death (POD) elections to bypass probate, which is a nice option, but it’s not ideal for every situation.
This article is a high-level overview of the various estate planning techniques and considerations when using revocable living trusts from the perspective of a wealth advisor (e.g. non-attorney). The US has 50 states – each with their own tax laws and estate planning opportunities. Accordingly, working with an estate planning lawyer in your state is a must. For example, in addition to community property laws versus separate property states, not every state recognizes the same forms of ownership for jointly owned, non-trust assets.
2 key benefits of living trusts
Although there are typically numerous benefits of utilizing a revocable trust, these are the two most common advantages.
1. Avoid probate (or at least reduce the probate estate)
As with many things in finance, there are varying degrees of implications in going to probate court. There are plenty of ways this can go wrong, but in one of the more common worst-case scenarios, one spouse owns virtually all of the liquid assets (and/or a closely-held business) in their own name and passes away first. This can leave the survivor without funds to pay regular bills while the probate estate is settled. One of the benefits of a living trust is the ability to avoid probate for assets held in trust.
In addition, probate will incur often-avoidable expenses and attorney fees. Depending on the state and family situation, it can take months or years to sort out. And assets that go through probate court are public record, which can create a host of other issues. Finally, a large, messy probate estate can also be an emotional and logistical burden on the surviving spouse and family, who frequently act as the executor of the estate.
Is a trust the only way to avoid probate? Not necessarily. As mentioned above, a TOD/POD can avoid probate for bank and brokerage accounts, as well as joint ownership for other types of assets.
2. Control the distribution of your assets
When assets go through probate, the court ultimately decides who gets what. It might end up aligning with your wishes, but it also might not. If the assets were held in a living trust, you could not only avoid probate (or reduce the probate estate), but also control the timing and distribution of the assets. And since trust documents aren’t part of the public record, all this can be done with discretion.
Here’s a simple example of how to put assets in a living trust:
You have a taxable brokerage account you own individually. You set up a living trust with an attorney and retitle the account in the name of your trust. When you die, the person you appoint as successor trustee will be legally responsible for distributing the assets in the living trust according to the terms you’ve specified in the trust document.
What are common terms of a trust?
It depends on the individual or couple’s goals, but typically, spouses arrange for varying levels of access during the surviving partner’s lifetime with the remainder to children or relatives. (Limiting access can provide estate tax planning benefits for some). Individuals might also decide (at the death of the first and/or second spouse) to leave assets or money to other family – aging parents, children from a different relationship, relatives, friends, charity, etc.
A trust can also help safeguard assets for minor children, provide for individuals with special needs, include terms if the survivor remarries, and also identify a successor trustee in the event of your disability, among other things. In contrast, if assets go to a spouse or heirs outright, these protections are lost.
Other living trust benefits
- State estate tax planning. States have their own estate tax laws. For example, the Massachusetts estate tax exemption is currently $2M per person. And unlike the federal exemption, the amount isn’t portable. With proper planning and legal support, a living trust may help ensure the exemption is preserved in the death of the first spouse.
- Equitable distribution of your assets. Many attorneys construct trust language to align with your wishes yet remain flexible enough to withstand time and certain legislative changes. This can include formulas to reduce the risk one heir gets more (or less) than intended. Tangible assets can also be ‘poured over’ the trust, sold, and then distributed in a proportion of your choosing.
- Flexibility. A key benefit of living trusts is that you retain control over the assets throughout your life. Barring any self-imposed limitations, during life, a living trust can provide complete flexibility for investing and spending trust assets.
Your estate plan should adapt to your needs over time
Your whole estate plan should be kept up to date and reflect your current circumstances and goals. A trust is just one part of an estate plan. People often wonder whether they need a trust or a will; often it’s both, as a trust cannot replace a will. Depending on your financial situation, legacy goals, and specific planning needs, a trust might only be one tool in your estate planning toolbox. Consider consulting an attorney to understand what structure might be the most beneficial for your objectives.
Article written by Darrow Wealth Management President Kristin McKenna, CFP® and originally appeared on Forbes.
Important disclosure: The material in this article is for general information and should not be misconstrued as the rendering of personal legal or tax advice. Consult an attorney to discuss your personal situation and estate planning needs. Darrow Wealth Management does not offer legal or tax advice.