All about Living Trusts!
A trust is formed by the transfer of property to another person as Trustee during the Grantor’s lifetime or by the decedent’s Will. The result is that the roles of ownership, control and beneficial interest of property are separated.
Ownership is a difficult concept to define in words, but we all know what it means to own something. For example, if Tom has $20 in his wallet, he has ownership of the money and complete control over where that $20 is spent. He further receives the beneficial interest, or enjoyment, of his purchase. The roles of ownership, control and beneficial interest are all concentrated in a single person.
Now consider that Tom hands his $20 to a babysitter and tells the sitter to use the money to buy the kids a treat if they are good. Now the babysitter has control over where the $20 is spent, and the children enjoy the beneficial interest of the purchase. If the children are not good, the money is returned to Tom. This arrangement is a perfect example of how a trust is formed because it is easy to relate to the division of the roles of ownership, control and beneficial interest.
Each trust must have three parties (though as you’ll see, the same person may serve in more than one of these roles)
- the creator of the trust (called the Trustor, Grantor or Settlor)
- a Trustee
- at least one beneficiary
In the babysitter example, Tom is the Grantor, the babysitter is the Trustee and the children are (happily) the beneficiaries. The details of how, when and why the Trustee can spend (or distribute) the property are all contained in the trust document. Therefore, a trust can be very simple (i.e. leaving the decisions to the broad discretion of the Trustee) or very complex (i.e. leaving detailed instructions for the trustee to follow). The trust document also provides for continuity of control by specifically listing successor Trustees or by providing a mechanism for appointing successor Trustees.
Benefits of Leaving Assets in Trust
Unlike a will, a trust that is set up for the benefit of your heirs provides those heirs with great creditor protection. You can be assured that their inheritance (as long as it remains in the trust) is exempt from the attachment, levy or garnishment of most creditors.
Further, because you can dictate the terms of the trust freely, a trust can be as simple or as complex as you desire, and therefore, the Grantor maintains more flexibility and control over the assets that they worked a lifetime to accumulate and build. In complex situations, such as where there has been a second marriage with children involved or a family business in which only a few heirs participate, the ability to finitely distribute assets is very beneficial.
However, Grantors should be cautious to avoid “legislating”. A “legislative” trust reads more like the statutory code of a State. For example, “my children will attend church every Sunday or they will not inherit a dime”. Since you cannot predict every contingency (such as the child did not attend church every Sunday because she was hospitalized or working as a missionary serving in a place where there is no church), the better approach is to appoint good people to serve as your Trustee. This way, you can confidently empower the Trustee to adapt to circumstances as they arise. A Trustee can be authorized to incentivize a child to become a contributing member of society (through employment or philanthropy), entrusted with the tools to react to the special needs of beneficiaries, or may even be able to shift the focus to the grandchildren and future generations while still providing a safety net for adult children.
Finally, from a non-asset preservation perspective, leaving assets to your heirs in trust can create that physical separation of the inheritance and the heir’s own assets, allowing them to appreciate the emotional importance of spending an inheritance. Thus, rather than co-mingling the decedent’s money with their own to be spent on random daily expenses, the heir receives the inheritance in a trust account giving them the opportunity to track the decedent’s legacy. Statistics tell us that regardless of a beneficiary’s age or the dollar amount inherited, most people will have exhausted the whole of their inheritance within 2-3 years. In community property states, the division can also help preserve the inheritance as the heir’s separate property.
In a Community Property state all property acquired during the marriage by either spouse is owned 100% by the Community (i.e. both spouses). For example, a wife purchases a car solely with the money that she earns from her job, with no contribution from the husband at all, yet that car is owned by both spouses. No spouse can be divested of their interest in any Community Property without his/her consent. So, the wife in our example cannot sell the car without the husband’s consent. This simple example makes the concept seem rather harsh, but the purpose is to recognize the contributions of both spouses to the marriage, and treat both spouses equally with respect to the marital estate, even if one spouse earns more money than the other.
Additionally, the laws of Community Property States automatically exclude certain property from the Community, such as property owned prior to the marriage, separate gifts and inheritances. Therefore, upon the passing of the first spouse, his/her separate property plus ½ of the community property is subject to probate unless the decedent has engaged in some kind of non-probate arrangement. The surviving spouse retains, not inherits, his or her one-half interest in the community probate assets.
Limitations of Living Trusts
Because a Living Trust is revocable and amendable by the Grantor at any time, you’ll want to be aware of a few limitations/considerations.
Expense of Drafting a Trust
Though they may seem rather simple, there are more moving parts to a Trust than to a Will. Small tweaks can really boost the efficacy of the trust for the Grantor and others can render the Trust useless so it’s best to have practiced hands drafting the Trust. This, of course, means there will be attorney fees to pay.
Titling Assets in the Name of the Trust
There is a bit of shift in habit required when a Trust is drafted. Any assets that are not specifically named in the trust are not included in the trust. This means that upon the death of the Grantor, that asset will be subject to probate. To maximize the benefits of your Trust, ALL assets must be titled in the name of the trust. So, you need to get used to opening new accounts or buying new real estate in the name of the Trust.
One headache that Grantors might encounter with putting their real property in the name of the trust is with lenders. Unfortunately, bank loan and underwriting requirements can be inexplicable and their treatment of trusts is no exception. In some cases, the lender views the Trust as an alter ego of the borrowers and basically ignores it all together. In other cases, the lender requires the borrower to retitle the real property in their individual names before a loan or equity line of credit can be approved. Doing so is not an overly burdensome process, so it should not deter you. Once you get the loan in place, you can easily transfer the real property back into the name of the Trust. Federal law prohibits lenders from accelerating the loan under the Due on Sale clause of a mortgage based on a transfer to a Living Trust.
Asset Protection
A Living Trust does not provide any asset protection for the Grantor (though, as discussed earlier, it does provide good asset protection for the beneficiaries after the Grantor’s passing).
If you are unsure whether a Living Trust is the right choice for you, consider the types of assets you own, where they are located (your state, another state or another country), family circumstances and how much control you want over how your assets are distributed. An attorney can help talk you through the decision.