Living Trusts

Avoid probate with responsible estate planning


Living trusts allow you to control who gets your assets after you die. However, there are many more reasons for creating a living trust. For instance, a living trust can help your beneficiaries avoid the expense and delay of probate. Probate can last as long as three years and can take up to 10% of your estate's value. A living trust can also provide you with more privacy than a will because you don't have to register it with the courts in probate. Living trusts can help avoid certain estate taxes if prepared properly. Finally, a living trust allows you to hand over management of your assets to someone else if you are unable to manage your assets yourself.


The Anatomy of a Living Trust

It is, admittedly, difficult to pin down what exactly a trust is. We could tell you that it is a legal entity that is capable of owning property. You can't see it. You can't touch it. You can't speak to it. So what does a living trust really do? 

A trust allows you to gather together in one document all your significant property. This is important if you want to make sure that your property is distributed easily and quickly after your death. The trust, not you, owns that property. This doesn't mean that you no longer have control of your assets. Since you, the grantor, will usually appoint yourself as the trust's initial trustee, you still have complete control of your property. You can do what you want with that property - you can even transfer some property out of the trust or add property to it. A living trust is an easy way to keep track of all your assets and manage them as a single unit. Most importantly, a trust allows you to provide for the quick and efficient distribution of your property to loved ones when you die. 

A living trust is created with a document known as a Declaration of Trust. This is the legal document which names your beneficiaries, describes your trust property, and provides for the terms of its transfer. The living trust is managed by the trustee; in most cases, the initial trustee is the person who forms the living trust. You may later designate someone else or an institution, like a bank, to act as a trustee. The trustee is also responsible for managing the property covered by the trust.


Living Trust vs. Will

Before we discuss the differences between wills and living trusts, let's look at their most important similarity. Both a will and a living trust allow you to set the terms for the distribution of your property after you die. The differences between the two, however, can be quite important. Before deciding which to use for your property you should consider the following advantages and disadvantages:




  • A living trust is a cost-saving device: in most states, it allows you to avoid the expense and delay of probate proceedings, which can take up to 3 years to complete and eat up 10% of the value of your estate.
  • If you own property in another state, a living trust eliminates the need to probate that property in that state.
  • A living trust can immediately transfer management of your property if you become incapacitated either physically or mentally. There is no need to go to the court to appoint a guardian or conservator.
  • A living trust protects your privacy; it remains confidential and does not become a matter of public record.
  • A living trust enables you to name someone you trust to manage trust property for young beneficiaries.
  • There is no need to hire a lawyer when the time comes to distribute your estate.


  • Setting up the trust requires quite a bit of initial paperwork and can be expensive.
  • Setting up the trust also requires you to transfer ownership of all the property you wish to place in the trust. This may include revising title documents.
  • You may run into some difficulty when you want to refinance property that is in your living trust.
  • Creditors do not have a final cut-off date for bringing claims against your trust.
  • You cannot designate a guardian for any minor children in a living trust (but this may be done easily in a will that supplements your trust).


  • Setting up a will is much simpler and less expensive than setting up a living trust.
  • Creditors face a final cut-off date for bringing claims against your estate.
  • You may name a guardian for your minor children in a will.
  • You do not need to transfer any property to another entity in order to create a will or make it valid.

  • Upon probate, a will becomes a matter of public record.
  • While you may appoint whomever you wish to act as executor of your will, it is usually the probate lawyers who control that actual distribution of your property. This can be both expensive and unpleasant.
  • Probate, which is necessary for the implementation of your will, can be both costly and slow.
  • A will does not provide for transfer of management of your assets or property if you should become physically or mentally incapacitated.

If you choose to create a living trust, you should also create what is called a pour-over will. It provides for the distribution of any property that is not included in the trust. It will also allow you to name a guardian for any minor children.


Probate and Reasons to Avoid It

Probate is the legal process that the courts use to implement a will. Probate typically takes six months to three years to complete. It may also require the service of a lawyer. Even if you die without a will your estate must still pass through the probate system. In that case, the court will decide how to distribute your estate among your relatives. The typical probate procedure includes the following steps:

a.     The will is filed with the local probate court (and becomes public record).

b.     Your family conducts an inventory of your property.

c.     Your property is appraised.

d.     All debts, including death taxes, are paid.

e.     The court validates the will.

f.      Court costs, attorney's fees and executor's fees are paid from the estate.

g.     Then, and only then, the remainder of the estate is distributed to your loved ones.

A living trust can help avoid probate. The reason for this is because your assets are placed into a trust, you do not "own" the assets, the trust does. You can still control the trust assets as if they were your own, but when you die, you do not "own" the trust property and therefore, you avoid probate for the assets placed into the trust. 

However, as previously mentioned, you will still need a simple will for any property not included in the trust. So long as all of your significant property is transferred into the living trust, then probating this pour-over will should be a rather simple process.


Transferring Property to Your Living Trust

In order to take advantage of the benefits of a living trust, you must transfer property into the trust. The person who transfers property into a trust is called a "grantor." In general, your most valuable property should be placed in your trust. This may include: your house; other real estate; business interests, including stocks, bonds and mutual funds; money market accounts; brokerage accounts; royalty contracts, patents and copyrights; jewelry and antiques; precious metals; works of art; and valuable collections.

  • Real Estate: Although you do not need to transfer real estate held in "joint tenancy" or "tenancy by the entirety" because it automatically transfers to the other person if one owner dies, it may still be a good idea to transfer this type of property into a living trust. This is because both owners could pass away in a common disaster, or the surviving owner could forget to place the property into a living trust at a later time. You should read your home deed to determine how the property is owned.
  • Small Business Interests: If you have a small business, sole proprietorship, partnership interests, closely-held corporation or LLC, you should consider placing the interest in the living trust. Please be aware that S-corporations have restrictions on ownership by trusts.

Property that is of little value need not be placed in a living trust, because it may be exempt from probate or subject to a streamlined probate process. Other items that usually need not be included are:

  • Personal Checking Accounts.
  • Property that you buy or sell frequently: This is especially true if you do not expect to own the property when you die.
  • Cars: Most cars are not terribly valuable and most insurance companies may be reluctant to insure a car owned by a trust. If, however, you do own a valuable car, it may make sense to check with your insurance company to see if it will insure cars owned by trusts.
  • IRA's, 401(k)'s, etc.: Technically, such accounts or funds cannot be owned by a trust. You can still avoid probate on these monies if you directly name a beneficiary to receive the funds in those accounts when you die.
  • Life Insurance: Your policy will directly designate a beneficiary.
  • Income or Principal from another trust: If you are entitled to leave interest or principal from another trust to your own beneficiaries, you may not do so through your living trust. You may do so only through your will.

Even after transferring your property into a living trust, you can sell your property in two ways. The first, and most common, approach is simply to sell the property directly from the trust. In that situation, the seller of the property is the trust, not you. The second approach, used mostly when an institution requests it, is to transfer the property out of the trust back to you as an individual and then sell it.


More on Real Estate

If, on the other hand, your real estate is not owned in joint tenancy or tenancy by the entirety, it can be included in a living trust. You will need to change the title of that property to reflect ownership by your trust. There are several issues peculiar to real estate that come into play when property is transferred into a trust. They are as follows:

  • Property tax reassessment: Most states, including California, do NOT require a reassessment when you transfer property into a trust of which you are trustee.
  • Transfer taxes: These taxes, which are normally assessed on real estate transfers, are generally not imposed when the transfer is to a living trust. However you should check with your CountyAssessor or Recorder's Office, because a few states do impose these taxes on living trust transfers.
  • Mortgage interest deductions: You, as the grantor, still have the right to deduct mortgage interest from your income taxes.
  • Insurance policies: You do not need to change the registration of insurance policies to the trust for policies that cover trust property.
  • Tax Breaks for the Sale of a Home: You still have the right to exclude $250,000 of profit from taxation when you sell your principal home, even if that home is owned by the trust.
  • Homestead Rights: Generally, these rights, which protect a homeowner's equity interest in her home, still apply to property covered by the trust - as long as a statement to that effect is included in the Declaration of Trust.
  • Due-On-Sale Clauses: Federal law prohibits lenders from enforcing these clauses when you transfer your principal residence to your trust. If you are concerned about this, however, you may want to get your lender's consent before the transfer.
  • Part Interests: You can transfer any part interest you have, such as a time share or percentage ownership, to your trust.

Distributions From the Trust

There are three types of beneficiaries of a living trust:

1.     Primary Beneficiaries: these beneficiaries are designated to receive specific property.

2.     Alternate Beneficiaries: these beneficiaries receive property if the primary beneficiary dies before you.

3.     Residuary Beneficiaries: these beneficiaries receive all property not left to either the primary and alternate beneficiaries.

In general, you may choose anyone or any entity you wish to be your beneficiaries. In a community property state, you are not required to leave anything to your spouse. That is because both spouses are deemed to own half of everything earned during the marriage. However, in separate property states, your spouse may have a strong claim to set aside part of your trust if you leave him or her less than one-third to one-half of your property. In addition, minor children in many states have the right to inherit the family residence. If a court finds that the challenger has a valid claim, your trust is not entirely invalidated. The court will modify the trust to accommodate the claims of your spouse and/or children. It is relatively easy to avoid these problems if you are careful when designating your beneficiaries.

You can leave property to children through a living trust. If you desire, you can keep the property in trust and designate an adult to manage the property on behalf of the child. This is called a children's sub-trust. The sub-trust will end when the conditions you specify are satisfied; for example, when your child turns 21 or when she graduates from college. It is important to remember that you cannot designate a guardian for your minor children through a living trust; you should do this through a traditional will. If you want to exclude a child from your trust you should state your intention explicitly. If it appears that you unintentionally overlooked one of your children in your trust, a court may modify the trust for that child's benefit.


Married and Unmarried Couples

Both married and unmarried couples can create living trusts. They can each create their own individual trust and/or a joint, shared living trust. Married couples should also factor in whether their state is a community property or separate property state. 

For most married couples, a basic shared living trust makes the most sense. Each member of the couple acts as a co-grantor and co-trustee of the trust. However, each person may choose any beneficiary she desires for her share of commonly owned property and for individually owned property in the trust. Both persons will have control over all of the property in the trust. Either person may revoke the trust at any time. If that happens, the ownership of the property returns to where it was before the trust was created. 

When one of the co-grantors (spouses) dies, the property originally contributed by that spouse will be distributed. Any property distributed to the surviving grantor will remain in the trust. The trust then continues until the death of the second grantor. 

On the other hand, there are several good reasons to create individual trusts. An individual trust may make sense if you and your spouse own most of your property separately. Individual trusts may also make sense for you if you do not want your spouse to have control over the property you contribute to the trust, or if you are recently married and want to keep your previously acquired property separate. 

You should keep in mind that creating individual trusts can be an awkward task for jointly-owned assets. That requires that you and your spouse sign and record two new deeds that transfer your half-ownership of the property to the trust. The best bet is to form a separate joint living trust for your joint assets.


The AB Living Trust

Some married persons prefer an AB living trust (also known as an exemption trust) to a traditional joint trust because of its flexibility and tax benefits. For many years, the AB living trust allowed married persons to escape certain estate taxes. Today, the future of this benefit is uncertain. Due to the Economic Growth and Tax Relief Reconciliation Act of 2001 ("The Act"), the estate tax will be gradually phased out until 2010, when it will be repealed. Unless further legislative action is taken, however, the estate tax will be restored to its pre-Act form in 2011. It is therefore difficult to determine what tax benefits, if any, an AB Living Trust bestows.

Yet, the AB living trust remains a powerful estate-planning tool. The estate tax is not scheduled for repeal until 2010, and as of today, will only be repealed for one year. The wise planner who wants to be prepared for every contingency can therefore still profit from an up-to-date AB living trust. The AB living trust affords a measure of security that your beneficiaries will receive the assets you earmark for them tax-free. Moreover, the flexibility afforded by a revocable AB living trust ensures that the trust instrument can be amended if circumstances change.

How an AB Living Trust works:

Imagine the typical joint trust with $3,000,000 in assets. If one spouse dies, the majority of the assets are commonly passed to the surviving spouse. In this example, assume that the husband dies and all of the trust property is left to the wife. Since there is no estate tax on amounts transferred from one spouse to another, the wife will receive the full $3,000,000 tax-free. But when the wife dies and leaves the property to the children, the trust is only tax exempt up to $1,500,000 (in 2005). The second $1,500,000 is subject to a very steep estate tax. The children, therefore, will receive substantially less than the $3,000,000 their parents meant to leave them and Uncle Sam will collect the difference

On the other hand, with an AB living trust, the surviving spouse never takes legal possession of the deceased spouse's property. The surviving spouse can use all of the income generated from the property plus additional amounts for support, but cannot sell it as he or she pleases. Since each spouse's share is kept separate, an AB living trust allows both spouses to use their estate tax exemptions, as opposed to just one. This translates into twice the tax savings and, thus, more money going to your beneficiaries.

Returning to our hypothetical couple, imagine that they set up an AB living trust with $3,000,000 in assets, rather than a similar joint trust. When the first spouse dies, say the husband, the trust splits in two. Trust A contains the husband's share of the trust property, which now becomes irrevocable. Assume that the husband's share is worth $1,500,000. This leaves the wife's share, contained in Trust B, worth $1,500,000. The wife cannot sell the property in Trust A (her husband's share), but is allowed to use the property and keep any income it generates. The wife can still use, sell, or bestow the assets in Trust B as she pleases.

When the wife dies, the trust property is distributed to the children. Assume the trust property totaled $3,000,000 at the time of her demise, with $1,500,000 worth of assets in Trust A and $1,500,000 in Trust B. Because the husband's share of the AB living trust was not immediately transferred to his wife when he died, the husband remains eligible for his $1,500,000 estate tax exemption. Thus, his $1,500,000 (Trust A) can be passed on to the children tax-free. Likewise, the wife is eligible for her $1,500,000 exemption. Her $1,500,000 (Trust B) can also be passed on to the children tax-free. Thus, the children take their $3,000,000 tax-free and thereby receives substantially more than they would have had their parents left them the money through the typical joint trust.

But AB living trusts are not without their disadvantages. The most important of these disadvantages is that the surviving spouse cannot sell their spouse's share of the trust property, held in Trust A, because it must be made available for the final beneficiaries. The surviving spouse is entitled to income generated by Trust A, however, and to certain allowances for his or her health and support. A further disadvantage may be the administrative cost of keeping an AB living trust. After the first spouse dies, the surviving spouse must keep separate books and records for Trust A and Trust B so as to utilize the trust assets properly. Finally, because the future of the estate tax is uncertain, acquiring the maximum tax benefits under an AB living trust is a tricky business that will vary from year to year. With an estate tax repeal set for 2010, even the most careful planner cannot be assured of any tax benefit whatsoever.


Estate Taxes

Estate planning is the process of organizing your financial and personal interests so that your wishes are met with a minimum of inconvenience and expense to your family. Estate planning also can assure that your estate incurs the minimum possible estate tax. The following is some general information regarding estate taxes:

  • The federal estate tax is imposed on the transfer of an individual's property at death.
  • The decedent's taxable estate equals the value of the total property transferred at death (the "gross estate") reduced by authorized deductions.
  • The gross estate can contain property interests of all kinds, including life insurance, jointly owned property, and under certain circumstances, property the decedent gave away before death.
  • The estate tax return must be filed within nine months after the date of the death.
  • There has been an increase in the amount of property that you can leave your heirs free of estate tax. In 2006, this allowance is $2,000,000, and it will gradually increase to $3.5 million by 2009. The highest marginal tax rate on the remainder of your estate will correspondingly drop from 50% in 2001 to 45% in 2009.
  • Due to the Economic Growth and Tax Relief Reconciliation Act of 2001, the future of the estate tax is uncertain. The estate tax is currently subject to complete phase-out in 2010 but a so-called "sunset" provision reinstates the estate tax in 2011.

If you have additional questions concerning the tax implications of a living trust or estate taxes, please consult with a licensed tax professional.

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