A living trust is a popular choices for people who want to know how to avoid probate. Living trusts provide the same benefits as other probate avoidance tools (such as beneficiary designations, joint ownership, and life estates), but without many of the drawbacks. Living trusts are the cornerstone of most estate plans that are designed to avoid probate.
What is a Living Trust?
A living trust is a relationship in which one party holds property for the benefit of someone else. Any living trust arrangement involves a relationship between the following three parties:
- Grantor – A grantor (also known as a settlor) is the person that transfers property to the trustee to place it into the trust.
- Trustee – A trustee is the person who holds legal title to the property placed into the trust. The trustee is responsible for using the trust property for the benefit of the beneficiary.
- Beneficiary – The beneficiary is the person who has beneficial title to the property. Although the trustee maintains legal title, the beneficiary has the true economic interest in the property.
The relationship between the parties is governed by a document called a trust agreement. The trust agreement identifies the people that will serve in each of these three roles. It also tells the trustee how to manage the assets that are transferred into the trust.
The terms “grantor,” “trustee,” and “beneficiary” refer to roles involved in the trust relationship. One person can play more than one role. In the typical living trust scenario, the person who establishes the trust (the grantor) also maintains control of the trust (as trustee) and the trust assets are used for his benefit (as beneficiary). In other words, one person can be the grantor, trustee, and current beneficiary of the trust. This is attractive to most people because it allows them to establish the trust without losing control or use of the trust property.
The roles involved in the trust arrangement can be played by different people at different points in time. For example, a trust can provide for one beneficiary during the life of that beneficiary, then provide for a different beneficiary or class of beneficiaries. It is not uncommon for a living trust to:
- Provide for the grantor during his life;
- Provide for the grantor’s spouse after his death; and
- Distribute assets to the grantor’s children after the death of the grantor and his spouse.
In this sort of arrangement, the first beneficiary would be the grantor; the second beneficiary would be the grantor’s spouse; and the final class of beneficiaries would be the grantor’s children. The role of “beneficiary” will have been played by different individuals at different points in time.
It is also common for the role of “trustee” to change over time. The person who creates the trust (grantor) usually serves as the first trustee. This allows the grantor to transfer assets to the trust without losing any control over the assets. When the grantor dies (or loses the mental ability to manage the trust), a successor trustee will step in to manage the trust in accordance with the grantor’s instructions. The successor trustee is usually someone named by the grantor in the trust agreement.
Once the trust agreement is signed, it becomes a legal entity that can own property (similar to a corporation or LLC). The living trust usually serves as the alter ego of the person who establishes it (the grantor). Because the grantor is the trustee, he or she can transfer assets into the trust without losing control over the assets. The grantor can still sell, gift, or otherwise deal with the asset as though he owned it outright. The grantor can also amend the trust if he changes his mind about anything. He can even unwind the entire trust arrangement by revoking the trust.
Note: Living trusts are called “living” to distinguish them from testamentary trusts, which are established in a Will and only become effective when a person dies. Unlike testamentary trusts, living trusts are effective when you create them and can remain in force throughout your lifetime and after your death.
How Living Trusts Avoid Probate
Living trusts are a great way to avoid probate. Like the other probate avoidance tools (joint tenancies, life estates, beneficiary designations), the key is not having any assets in your own name at your death. Here’s how it works:
- A trust agreement is prepared to establish the trust. In most cases, it is best if an attorney prepare the trust agreement. There are several online options for people who want to try it themselves, but keep in mind that the cheapest route isn’t always the best. An improperly drafted or funded trust can be disasterous.
- In the typical situation, the trust agreement names you to serve as the first trustee and beneficiary of the trust. This allows you to keep complete control over your assets, as though you still owned them outright.
- All of your assets are transferred into the living trust during your lifetime or otherwise titled to pass automatically at your death (through beneficiary designations or joint ownership). This could require the preparation of deeds to real estate and re-titling of your financial accounts.
- If you become incapacitated, the person you have named to serve as successor trustee steps in to manage the assets for your benefit in accordance with the terms of the trust.
- At your death, all of your assets will have already been transferred into your trust or otherwise titled as non-probate assets. On paper, you will not own anything at your death (even though you had the same rights of ownership throughout your lifetime). Because you have no probate assets, there is no need to probate your estate.
- After your death, the successor trustee handles your assets in accordance with your wishes. The trust can last for a period of time (such as throughout a spouse’s lifetime or until children reach a certain age), or it can terminate immediately at your death.
The beauty of this arrangement is that it avoids probate without sacrificing control of your assets—a win-win situation for many clients.
The Importance of Funding the Living Trust
As mentioned above, the trust becomes a legal entity when the trust agreement is signed. At that point, it is just a shell. The only assets it holds will be the initial assets used to set up the trust (usually a nominal amount such as ten dollars). You will need to transfer assets into the trust, a process known as funding.
It is important to remember that a living trust only governs assets that are transferred into the trust. The best living trust in the world will not avoid probate you die with probate assets that are still in your name alone. In other words, an unfunded or improperly funded living trust does not avoid probate.
It is important to review your asset profile to be sure that every titled asset (like financial accounts or real estate) is either titled in the name of the trust or otherwise qualifies as a non-probate asset. Non-titled assets should be transferred to the trust using an assignment of personal property or similar document. If you do not title your assets to work with your trust, probate will still be required even though you have set up a living trust.
Note: The failure to properly fund a living trust is the most common error of estate plans incorporating living trusts.
Why a Living Trust is Usually the Best Tool for Avoiding Probate
The key to avoiding probate is arranging your assets so that there is nothing in your name that does not automatically pass to someone else at your death. In other words, probate is avoided if all of your assets are titled as non-probate assets.
Living trusts are not the only way to create non-probate assets. We have discussed other tools, including joint tenancies, life estates, and beneficiary designations. But each of these tools has significant drawbacks. A living trust avoids many of the drawbacks of these other probate avoidance techniques. For example:
- A living trust does not require you to share control of the assets during your lifetime.
- A living trust does not open up the asset to the potential claims of any creditors of other owners.
- A living trust is accessible during your lifetime if you become unable to manage your assets on your own (stronger incapacity planning).
- A transfer to a revocable living trust can be structured as a non-event for federal purposes, avoiding any federal and/or state gift taxes for the transfer.
- A living trust does not cause adverse basis consequences.
- Depending on your state laws, your living trust may be set up to retain any homestead exemptions that you currently qualify for.
- A living trust provides seamless transfer of control to the person that you choose. On the earlier of your death or incapacity, that person simply assumes control of the trust, without court involvement.
- Because you retain control of the living trust during your lifetime, you can sell or otherwise deal with the assets of the trust without involving anyone else.
- Living trusts can avoid probate in more than one estate. For example, a husband’s living trust can be set up to provide for his wife during lifetime, then transfer the assets to their children after his wife’s death. This avoids probate in both the husband’s and the wife’s estate.
Because living trusts achieve the benefits of probate avoidance and incapacity planning without any of the drawbacks of other probate avoidance techniques, they form the cornerstone of most estate plans that are designed to avoid probate.
Note: While living trust can be structured to minimize taxes, the same tax benefits can be achieved through a will-based estate plan that incorporates testamentary trusts. This is because your taxable estate does not always match your probate estate. It is important to consult with a trust attorney to determine the best strategy for accomplishing your overall estate planning goals.
Related Information
- 01 – Introduction to Avoiding Probate
- 02 - Avoiding Probate with Joint Tenancies
- 03 - Avoiding Probate with Beneficiary Designations
- 04 - Avoiding Probate with Life Estates
- 05 - Avoiding Probate with Living Trusts
About Jeramie Fortenberry
