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A living trust is a type of estate planning tool that allows you to transfer ownership of your assets to a separate fund while you're still alive.
Figuring out who should get your money and property (assets) after you die can be tough. You want to ensure that each heir gets the right amount, in the way you want to give it and without unnecessary delays. For this reason, a living trust can be very attractive. It's similar to a will, but with some distinct advantages.
Assets you place in a living trust do not have to pass through a potentially lengthy and costly probate process, as they would with a will. That means your heirs will obtain what you want to give them much more efficiently. It will also allow them to maintain privacy in a way that a public record last will and testament does not allow. In some circumstances, you can use a living trust to protect money you owe to creditors.
There are a couple types of living trusts, and your debts and assets are treated differently depending on which type you choose.
How Does a Living Trust Work?
There are two basic types of living trusts: revocable and irrevocable. Both allow you to assign your property to specific heirs or organizations. When you die, the property will go to them as instructed. In this way, living trusts are similar to wills. Yet instead of the property going through probate court, which can be expensive and time-consuming, the trustee you assign will simply distribute the assets according to your wishes. The process can be resolved in just a few weeks, as opposed to a will which can take months or even years to resolve.
Here's what you should know about the two main types of trusts:
- Revocable trust: A revocable trust allows you change it as often as you like before you die. While you're alive, everything in the trust is considered your personal property. When you die, the assets in the trust are considered part of your estate, and the successor trustee you assigned controls distribution. The trust ceases to exist after everything has been given away. Its primary purpose is to avoid probate court, since revocable living trusts do not reduce estate taxes.
With a revocable trust, your assets will not be protected from creditors looking to sue. That's because you maintain ownership of the trust while you're alive. Therefore if you lose a lawsuit and a judgment is awarded to the creditor, the trust may have to be closed and the money handed over. - Irrevocable trust: With an irrevocable trust, nothing can be changed after you sign it. At that point, everything listed becomes the property of the trust. The assets are no longer yours, so you will not be subject to estate taxes. Additionally, the assets placed in an irrevocable trust cannot be pursued by creditors seeking payment of debt. If an irrevocable trust was signed with the intention of defrauding creditors, however, legal repercussions may be enforced. There are several varieties of irrevocable trusts, including types specialized for life insurance payouts or funeral costs.
With this kind of trust, assets are more protected from creditors. Since all property in it is no longer yours, a judgment creditor can't force you to close the trust to reconcile an amount due. An exception to this rule is if fraud was involved. If you used the trust to illegally escape paying your bills, that trust may not be as airtight as you think.
Who Living Trusts Are For
No matter which type of living trust you choose, they aren't just for high net worth individuals. They're also appropriate for people who are concerned about illness or injury. The person you name as successor trustee will step in to manage your financial affairs if you can't.
Do you worry your heirs may not respect your wishes and will fight it out in court? Unlike wills, living trusts rarely are contested. If you have children and want to give them money in increments rather than all at once, you can have that happen with a trust. In fact, by putting assets in a trust, you can make sure your surviving spouse keeps the money instead of it going to his or her new spouse (remarriage protection). That goes for your married children, too, as you can stipulate that the money won't go to their exes should they divorce.
Keep in mind that you may want both a living trust and a will. Living trusts only include the things you put in them, while a will can include everything else. And if you have minor children, you can name a legal guardian for them in a will but not in a living trust.
Steps to Setting Up a Living Trust
- Decide which kind of trust you want. For maximum flexibility, a revocable trust is best because you can adjust it as many times as you like while you're alive. In general, irrevocable trusts are best for those who have extensive assets, since these trusts offer greater tax benefits and asset protection.
- Know what you'll put in the trust. Typical assets to include in a trust are homes, stocks and bonds, ownership of a business, patents and copyrights, and personal items such as furniture or artwork.
- Name your beneficiaries. They can be people as well as organizations.
- Identify the successor trustee. This will be the person who manages the trust after you die, so you'll need his or her acceptance.
- Name a money manager. If you have minor children, you'll want to name someone you trust to administer the inheritance. You may consider whomever you've named as a guardian for your child or children.
- Prepare the trust. You can do it yourself with legal softwarel or work with an attorney.
- Transfer property ownership to the trust. If you're not working with an attorney who will guide you, discuss the matter with your broker and relevant banks.
Once you're done, keep your trust document in a safe deposit box or fireproof safe, and tell the successor trustee where to find it.
How Assets and Debt Are Handled After Death
After your death, the successor trustee takes over. It's a big job. That person will distribute the assets in the trust, but will first have to satisfy any outstanding debts, such as taxes, collection accounts and credit card bills. He or she will have to identify all the creditors, prepare income and estate tax returns and pay any ongoing bills. If more money is needed to pay off the creditors, the trustee may have to raise it by liquidating accounts or selling property.
The distribution of assets also requires considerable effort. Bank and investment accounts will be straightforward, but property such as real estate, cars, jewelry and artwork is more complicated, as it will need to be professionally appraised for its date-of-death value. To obtain those written appraisals, the trustee may first have to get an affidavit that proves his or her authority.
During this time, the trustee will keep the beneficiaries up to speed on what's going on, and then will start to transfer the assets. Bank and investment accounts will be passed to the named beneficiaries. Any property that has a title, such as homes and vehicles, will require the trustee to prepare and sign a new title document to transfer ownership to the beneficiary. For items such as jewelry and furniture, it's a matter of handing it over or arranging for the beneficiaries to pick them up, an exchange that will require a signed receipt.
Can a Living Trust Affect Your Credit?
Evidence of a living trust will be absent from your credit report, so it will have no impact on your credit history or credit scores. However, as with virtually all financial decisions, there could be an indirect effect.
For example, if you want to apply for a loan or buy a home, you'll be listing your assets. Lenders will want to know what you have in reserve because it helps them to assess risk. If you have a revocable trust, the lender knows that the assets in the trust are available in the event that you default. That reduces their risk. On the other hand, if a large portion of your assets are tied up in an irrevocable trust, lenders have no claim to that property, so you won't be able to list it as an asset. That may hurt your ability to qualify for the credit product you want.
The bottom line: Living trusts are designed to help your heirs receive the amount you want them to have, with few extra costs and without unnecessary hold-ups. You can be sure they get the amount you intend by paying off your debts before you pass on.