In the realm of estate planning, living trusts stand out as a versatile and powerful tool for safeguarding assets and ensuring a smooth transfer of wealth to heirs. This article sheds light on the intricacies of living trusts: explaining how they work, who can benefit from them, and how they can be tailored to best align with your own unique financial circumstances. Let’s dive in.

What is a living trust?

A living trust is a legal arrangement whereby an individual (the grantor) places assets into a trust during his or her lifetime. Though revocable living trusts are most common overall, irrevocable trusts exist as well.

With a revocable living trust, the grantor can personally name the trustee and maintain control over the assets/trust itself; this includes modifying the trust as necessary (e.g., adding or removing beneficiaries, changing the trustee, removing assets, or even terminating it altogether). So long as the grantor is living, he or she will continue to pay taxes on trust assets—with a designated successor trustee taking over asset management upon the grantor’s incapacity or death. As for whether or not to move ahead with a revocable versus irrevocable living trust, many people choose the former when they want their assets to avoid probate, believe their wishes for the same will change over time, and/or when the value of their estate falls below the federal tax exemption.

With an irrevocable living trust, on the other hand, the grantor cannot name him or herself as a trustee; the trust owns the assets, and the trustee is the custodian of those assets (which are thus no longer part of the grantor’s taxable estate). Just as the name implies, it’s incredibly difficult to make changes to an irrevocable trust after it’s created; the beneficiaries are set, and the grantor may not repossess the assets. Furthermore, changing provisions in an irrevocable living trust often requires court approval.

As for reasons why someone would opt for an irrevocable trust, some of the most common include to minimize estate taxes, protect assets from creditors and lawsuits in the future, and/or qualify for government benefits such as Medicare.

Trustee duties and responsibilities

Though the grantor often names him or herself as the trustee of a revocable living trust, the role of trustee carries a lot of responsibility with respect to an irrevocable living trust (or the designated successor trustee of a revocable living trust): playing a vital role in trust management.

For example, the trustee must act in the best interest of beneficiaries and follow the grantor's instructions as outlined in the trust agreement. He or she is also responsible for managing and investing trust assets, maintaining thorough records of all transactions, keeping beneficiaries informed about trust status, and ensuring the trust complies with all tax obligations including income, estate, and gift taxes. Finally, should the grantor become incapacitated or pass away, the trustee is responsible for distributing trust assets per trust agreement instructions.

Estate taxes and living trusts

One principle estate planning concern is minimizing estate taxes; irrevocable living trusts can be an effective tool to help do so, especially if the value of the estate eclipses the deferral estate tax exemption. Depending on the trust beneficiary and your own financial circumstances, you can consider a few potential options in this respect: including A/B trusts (also known as marital trusts), irrevocable life insurance trusts (ILITs), and charitable remainder trusts (CRTs). All three seek to limit estate taxes but do so in different ways:

·      An A/B trust allows a married couple to create a joint trust that maximizes estate tax exemptions on the part of both spouses.

·      An ILIT can provide a means to pass on life insurance proceeds outside of the taxable estate.

·      A CRT can provide beneficiaries with an income stream while benefiting a charitable cause, potentially reducing the taxable estate.

Additionally, an irrevocable living trust enables one to implement gifting strategies—such as annual exclusion gifts—to reduce the overall taxable value of an estate.

It's important to note that estate tax laws constantly evolve, so you’ll need to consult with a knowledgeable estate-planning attorney or financial advisor to ensure your own individual plan aligns with the current legal landscape.

Benefits of a living trust

Living trusts offer several advantages that make them a preferred choice for many, including:

Probate avoidance
Probate is a process whereby the courts validate a will prior to asset distribution. One of the most significant advantages of a living trust is that its assets are not subject to probate, helping to save both time and money. With the right successor trustee in place, transiting assets from the grantor to beneficiaries is typically swift and efficient.

Privacy
Unlike wills—which become public record upon probate—living trusts remain private. This means financial affairs remain confidential, protecting the family of the deceased from unwanted public scrutiny.

Incapacity planning
Living trusts extend beyond just end-of-life arrangements; they can also provide for care and asset management in the event of incapacitation, meaning the successor trustee can step in and manage the grantor’s finances in the absence of a conservatorship.

Flexibility
Living trusts are highly customizable, meaning you can structure them to meet your specific goals and accommodate various types of assets. For example, if a grantor is concerned about an adult child’s ability to manage assets due to a lack of money management skills, addiction, illness, or any other reason, he or she can place conditions on the trust for peace of mind.

How to create a living trust

A living trust is a complex document, and you should always work with an attorney and your financial advisor to ensure the trust is set up correctly. With respect to the process itself, however, establishing a living trust involves only a few fairly simple steps.

The first (and most crucial!) step is selecting a trustee. This person or entity will manage the trust and distribute assets according to your wishes, and many people in fact choose themselves as the initial trustee (if the trust is revocable) while designating a successor trustee to take over when necessary.

You’ll need to consult with an attorney to create a trust agreement outlining your wishes and how the trust should be managed. Be sure to specify how you want your assets distributed upon your death or incapacity, and after the trust agreement is drafted, you—as the grantor—must sign the document in the presence of a notary public.

You'll also need to transfer your assets into the trust, which involves changing their title to the trust's name. Assets can include real estate, bank accounts, investments, and/or personal property.

Additionally, if your living trust is revocable, you’ll want to regularly review and update it as your financial and/or family circumstances evolve over time: ensuring it remains an effective tool for your estate-planning needs.

Living trust vs. will

While both living trusts and wills serve as essential estate planning tools, their distinct differences may make one more suitable for you than the other—depending on your circumstances. Both also have limitations; for example, a living trust cannot appoint a guardian for your children (meaning that if you have minor children, you’ll need a will whether you have a living trust or not).

Depending on your circumstances, the best estate-planning strategy may involve a combination of a living trust and will: thus ensuring all assets are appropriately managed, with the former addressing more complex or high-value assets and the latter serving other specific purposes such as appointing guardians.

Common living trust myths

Several myths surrounding living trusts can deter individuals from exploring this valuable estate planning tool. A few of the most common misconceptions include:

Living trusts are irrevocable
Living trusts can be either irrevocable or revocable. If you want the option to amend or even revoke your trust during your lifetime, you can always choose the latter (with this flexibility shining through as one of its key advantages).

Living trusts are only for the wealthy
Contrary to popular belief, living trusts can benefit all individuals—not just the affluent. Associated benefits including probate avoidance, privacy, and incapacity planning are relevant to people from all walks of life no matter their financial circumstances.

Living trusts are only for older individuals
Estate planning is not exclusively for senior citizens; younger individuals can also benefit from living trusts, especially if they have significant assets and/or want to ensure a smooth wealth transition should an unexpected event occur.

The importance of professional guidance

As creating a living trust is a significant financial and legal decision, one should seek professional guidance throughout the entire process. An experienced estate-planning attorney and financial advisor can help assess your own unique financial situation, designing the trust to meet your specific goals, ensuring you comply with all applicable laws and regulations, and updating the trust over time as necessary.

Working with a professional can also potentially save you money. With a deep understanding of tax laws and financial strategies, professionals can help you structure your trust to maximize tax benefits while reducing your overall tax liability.

Key takeaways: living trusts

A living trust is a powerful estate-planning tool that can provide flexibility and privacy while minimizing probate and estate taxes. Nevertheless, it's crucial to recognize this is not a one-size-fits-all solution; your unique financial situation and family dynamics should guide the structure and implementation of your living trust accordingly. Working with a professional can help ensure your living trust fully meets your needs, takes full advantage of tax-saving opportunities, and complies with all laws and regulations in the complex and ever-changing estate-planning world. With the proper guidance, you can safeguard your legacy for your loved ones, minimize taxes, and enjoy the peace of mind that comes with a well-structured living trust.

Still have questions about living trusts? Schedule a FREE Discovery call with one of our CFP® professionals.

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Vision Retirement is an independent registered advisor (RIA) firm headquartered in Ridgewood, New Jersey. Launched in 2006 to better help people prepare for retirement and feel more confident in their decision-making, our firm’s mission is to provide clients with clarity and guidance so they can enjoy a comfortable and stress-free retirement. To schedule a no-obligation consultation with one of our financial advisors, please click here.

Disclosures:
This document is a summary only and is not intended to provide specific advice or recommendations for any individual or business. 

Tax information was sourced by various online sources, including Kiplinger, SmartAsset, RetirementLiving, the Tax Foundation and various state websites.