What Is a Living Trust?

A living trust is a legal document which enables a grantor, or asset owner, to assign assets during her lifetime to a beneficiary after her death.

The grantor can appoint a trustee – an individual for managing the trust – or function as a trustee herself.

In the latter case, the grantor must name a trustee to take over her duties after her death.

A living trust is generally used to make succession plans for large and complex estates that might span multiple types of assets, such as property and financial instruments like stocks.

The trust helps grantors avoid lengthy court-mandated probate settlements and provides income to them during their lifetime.

In some instances, like those for irrevocable living trusts, a living trust can also cut down on tax liabilities and provide protection against creditors.

The drawbacks of living trusts are that they can be expensive to maintain and, depending on the type of trust, they can “lock up” assets during the grantor’s lifetime, preventing changes to their status and terms even if circumstances change.

How Do Living Trusts Help in Estate Planning?

Trusts are a type of legal agreement for passing on property and other assets. Living trusts are examples of inter-vivos trusts i.e., they are made during a person’s lifetime and specify conditions for passage of assets, subject to certain criteria, to beneficiaries.

Wills, which serve a similar purpose in estate planning, are a form of testamentary trust because they are testaments for distribution of an individual’s assets after his or her death.

Living trusts are often compared to wills because both types of documents are used to plan for estates and pass on assets and property.

But there are a couple of differences between the two.

The first and most important one is that all wills have to undergo a fairly lengthy and expensive process called probate before funds are disbursed.

Probates determine a will’s validity, its beneficiaries, and assess the value of assets mentioned in the document.

Subsequently, creditor checks are performed, debts paid, and pending taxes are filed.

Only after the completion of these processes are disbursements from the will made to beneficiaries.

The entire process can be fairly complicated, especially if the estate spans several geographical boundaries.

This is mainly because each state has its own set of inheritance laws to deal with different types of assets and situations.

A living trust simplifies matters and bypasses the probate process by placing the individual’s assets in a legal vehicle.

The second major difference between wills and trusts lies in their timeframes.

A will becomes operational only after a person’s death.

On the other hand, a living trust is created during an individual’s lifetime and becomes operational immediately after its creation.

This means that the trust can provide income to grantors or, depending on the terms set forth during the creation process, pass onto other individuals at a later time when the grantor suffers a mishap or is mentally incapacitated.

Differences apart, both documents are also similar to each other in that they are fundamentally used to pass on assets and funds from one generation to another.

Just like in a will, you can specify trust beneficiaries or change the trust’s terms in revocable trusts.

You can also attach conditions for disbursement of funds and specify lists of activities to be performed with the trust’s holdings after your death.

Types of Living Trusts

Living trusts essentially fall into two categories.

Revocable living trusts are trusts that can be revoked or annulled by the grantor before their term.

Such trusts are flexible and their composition and terms can be changed.

For example, the grantor may change the beneficiaries for a trust or withdraw assets from a trust based on the current situation.

Irrevocable trusts are the opposite of revocable trusts. They cannot be changed i.e., they are not flexible.

You cannot change the terms or composition of such trusts after creating them even if there is a change in circumstance.

For example, you cannot withdraw assets or funds from the trust during emergencies.

But irrevocable trusts offer tax advantages and protection from creditors, in some cases.

What Are the Advantages of a Living Trust?

The main benefit of living trusts is their legal standing to circumvent the court-supervised probate process.

The general settlement process for living trusts is much quicker as compared to wills.

This makes them less expensive and easier to settle for the beneficiary because they do not have to shell out court fees or travel extensively to prove their claims for complex wills.

Other benefits of living trusts are outlined below:

  • Living trusts provide privacy. A will becomes a public document once it is admitted to the probate process. This means that anyone, including creditors and the general public, can view it. Living trusts are private and only parties relevant to the trust, such as beneficiaries and trustees, can view it.
  • Irrevocable living trusts provide tax benefits to grantors. Grantors are responsible for capital gains tax for assets held in revocable living trusts. In the case of irrevocable living trusts, however, the taxes accrue to the trust and save the grantor from liabilities. Irrevocable living trusts may also offer protection against creditors in states that have such provisions. Examples of states with such laws are North Dakota and Maine.

What Are the Disadvantages of Living Trusts?

For all their advantages, living trusts also come with certain disadvantages. Some of them are listed below:

  • Living trusts have the advantage of providing grantors and beneficiaries with an income stream that can be used for expenses or emergencies, during their lifetime. But that advantage goes away with an irrevocable living trust. In such trusts, assets are “locked up” inside it, meaning the grantor cannot make changes to the trust’s terms or withdraw assets from it. This can be a challenge, especially during emergencies. For example, what if a grantor is involved in an accident or has a debilitating illness that requires expensive treatment? An irrevocable living trust makes it difficult for him or her to access the funds held inside it.
  • Trusts are expensive to set up and maintain. During the trust set up process, assets intended for it must be retitled, meaning the grantor must transfer ownership and, for some living trusts, control of the assets to the trust. This process can be time-consuming and involves lots of paperwork. Depending on the estate’s complexity, court and lawyer fees during the retitling process can also add up to a fairly pretty packet. Thereafter, it is the grantor’s responsibility to maintain the trust. Yearly maintenance fees of the trust, that include review and updating of provisions for the trust, can add up over a grantor’s lifetime.
  • After assets are assigned to a trust, it can become difficult or cumbersome to use them for other purposes. This is primarily because grantors lose ownership of the assets to a trust. For example, refinancing property that has been assigned to a trust can be pretty complicated. It may involve transferring the property out of the trust, changing the title deeds, refinancing the property, and transferring ownership of the refinanced property back to the trust through title deeds.
  • Living trusts can also be sued by creditors for an unlimited time period. Even after the trust is executed and beneficiaries have begun receiving payments from it, creditors can still lay claim on the trust’s holdings. This is unlike a will, in which a set period during the probate process, is generally reserved for creditor claims.

How Can You Create a Living Trust?

Creating a living trust can be a fairly simple or complicated process.

It depends on the contents of your estate.

Some of the questions that you must ask yourself before creating a trust are:

  • Are your assets spread across geographies?
  • Do you have no problems with assigning your assets to a trust for their lifetime?
  • Do you have several beneficiaries, individuals and organizations, in mind for a trust?
  • Do you want to assign a trustee i.e. an individual to take care of your beneficiary’s financial matters?
  • Are you interested in a trust that is flexible or are you interested in tax benefits from a trust?

Once you have decided to create a trust (instead of a will), create a trust deed listing your assets and beneficiaries.

While it sounds simple, the process to do this can be pretty knotty.

Since assets in a trust are not owned by you, you will need to transfer legal titles to the trust and establish terms of ownership and control for them.

You should also identify beneficiaries and establish terms for them to inherit the trust’s contents after your death.

Finally, you will also need to decide whether you require a trustee while you are still alive or if you need a co-trustee who can take over after your death.

Depending on the nature of the trust (whether it is revocable or irrevocable), you can either be your own trustee or assign the job to a third-party organization or an individual.

A living trust deed is essentially a legal document that assigns the assets you have shortlisted to a financial vehicle.

To that end, you need to check the existing requirements for a trust in your state and draw up a document that adheres to those requirements.

Funding the trust or conveyance of assets to a trust is next.

In this step, you will list assets to a trust.

The final step consists of notarizing the trust document.

Nowadays, living trusts can be drawn up using software that customizes the trust deed based on the jurisdiction and terms.

This process may work for simple and straightforward cases.

For trusts that are more complex, it is advisable to consult a lawyer or a specialized attorney who has experience with crafting trusts.

Living Trust FAQs

A living trust is a legal document which enables a grantor, or asset owner, to assign assets during her lifetime to a beneficiary after her death.
A living trust is generally used to make succession plans for large and complex estates that might span multiple types of assets, such as property and financial instruments like stocks.
The trust helps grantors avoid lengthy court-mandated probate settlements and provides income to them during their lifetime.
Living trusts essentially fall into two categories. Revocable living trusts are trusts that can be revoked or annulled by the grantor before their term. Irrevocable trusts are the opposite of revocable trusts. They cannot be changed i.e., they are not flexible.
With an irrevocable living trust, the grantor cannot make changes to the trust’s terms or withdraw assets from it. This can be a challenge, especially during emergencies. For example, what if a grantor is involved in an accident or has a debilitating illness that requires expensive treatment? An irrevocable living trust makes it difficult for him or her to access the funds held inside it. Also, trusts are expensive to set up and maintain. Assets intended for it must be retitled, meaning the grantor must transfer ownership and, for some living trusts, control of the assets to the trust. This process can be time-consuming and involves lots of paperwork.
True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, his interview on CBS, or check out his speaker profile on the CFA Institute website.