A Trust can solve a lot of problems. But like all tools, it can also be misused.
If you're putting together an estate plan, you have no doubt heard about the benefits of a living trust. Assets placed in a trust won't go through probate, a time-consuming and potentially costly process. In addition, a living trust, also known as a revocable trust, allows you to designate a trustee to manage your estate after you're gone—an important consideration if your heirs are minor children or adults who are unable to handle a large inheritance.
But although living trusts can streamline the disposition of your estate, there are plenty of opportunities to make costly missteps, particularly when it comes to transferring your assets to a trust.
Some types of accounts should never go into a trust, even if they account for the bulk of your estate. That category includes assets in your retirement accounts, such as your 401(k) plan, IRAs and tax-deferred annuities. Health savings accounts and the less-common medical savings accounts, which allow you to take tax-free withdrawals for medical expenses, should also be excluded from your trust.
If you transfer any of these accounts to your trust, the IRS will treat the transaction as a distribution and you'll have to pay income taxes on the entire amount, says Kris Maksimovich, president of Global Wealth Advisors in Lewisville, Texas. Maksimovich says one of his clients recently transferred an IRA to a trust; fortunately, he was able to unwind the transaction before the distribution was taxed.
You can make your trust a beneficiary of your retirement accounts, which is what Maksimovich did for his client's IRA. Naming your trust as a beneficiary allows you to determine how the assets will be distributed to your heirs and could also protect the funds from creditors. However, the 2019 Setting Every Community Up for Retirement Enhancement (SECURE) Act, which requires non-spouse beneficiaries to deplete inherited IRAs in 10 years, created some uncertainty with respect to how long a trustee has to deplete an IRA that's left in a trust, so consult with an attorney before naming the trust as beneficiary.
Most other assets can be placed in a trust, but some should probably be excluded for practical reasons. For example, in order to transfer a vehicle to a trust, it must be retitled, which can trigger taxes and fees, depending on where you live. In addition, cars and other vehicles, such as boats and motorcycles, typically don't go through probate, so you don't need to transfer them to a trust.
Also, although most accounts with financial institutions belong in your trust, you should exclude accounts used to pay your monthly bills. Some entities, such as your utility company, may not accept payments unless they're in your name, Maksimovich says. In addition, your bank may require you to close the account and open a new one in the name of the trust. For those reasons, it's simply easier to keep those accounts outside the trust.
Another common misstep is to set up a trust and then fail to fund it. Funding a trust typically involves retitling property and financial accounts. You and your attorney should come up with a detailed inventory of assets that belong in the trust:
It may be your largest asset, and it's an appropriate one to place in your trust. Doing so will decrease the time required to transfer the home to your heirs. And if you own property in another state—a vacation home, for example—transferring the title to a living trust will enable you to avoid going through probate in more than one state. You'll need to create a new deed that transfers ownership of the property to your trust.
Transferring your home to a trust won't affect your ability to sell it, says Letha McDowell, an attorney with the Hook Law Center and president of the National Academy of Elder Law Attorneys. However, if you want to refinance your mortgage or obtain a home equity line of credit, your lender may require you to transfer the property out of the trust and back to your name in order to get the loan. Once you've completed the transaction, you can transfer the property back to the trust. But because this process can be cumbersome, you may want to postpone transferring your home to a trust until after you've refinanced or closed on a HELOC or home-equity loan.
Financial accounts that can be transferred to a trust include stocks, bonds, mutual funds and other investments in nonretirement accounts; certificates of deposit; money market funds; and bank savings accounts that aren't being actively used to write checks. You can put your safe deposit box in the trust, too.
This process requires some paperwork. For bank and brokerage accounts, you'll need to open a new account in the name of the trust. If you have any physical stock and bond certificates, you may need to work with a stock transfer agent or bond issuer to change ownership to the trust. You may need to open a new CD to fulfill the transfer, so ask your financial institution if it will waive penalties before making the switch.
If this seems like a lot of work, consider it a gift to your heirs. Transferring inherited shares of stock or mutual funds to an estate (outside of a trust) can take months, during which time your heirs will be required to fill out lots of documents and probably make a few phone calls, all of which can delay probate.
You usually don't need to retitle these types of assets, but you should draw up a list with instructions that they should be included in the trust. You can use the trust to designate who should receive these items, which should prevent family disputes over who gets your grandmother's pearls. You can also provide this type of direction in a will, but a will becomes a matter of public record—not desirable if grandmother's pearls are worth a lot of money. And while the car you drive around town probably doesn't belong in a trust, you may want to include any collectible vehicles you own, particularly if you think the vehicle will retain its value or appreciate over time.
Once you've transferred and retitled assets that belong in your trust, you should review it periodically to make sure it's up to date. Maksimovich says he reviews his clients' trusts annually. In other cases, every three to five years may suffice, but you may need to review (and possibly update) the trust after a major life change, such as the sale of your home, the birth of a child or grandchild, or a marriage or divorce.
As we've explained, funding a living trust requires some legwork, and there is also the issue of cost. Depending on where you live, expect to pay $1,000 to $1,500 in legal fees, compared with $200 to $500 for a basic will.
A living trust may be worth the cost if it reduces the hassles of going through probate. If you've served as an executor of an estate, you may already be aware of what's involved. “No one appreciates avoiding probate more than someone who has gone through probate,” Maksimovich says.
But the exigencies of probate vary, depending on where you live. “There are some states where it's horribly expensive and time consuming and others where it's not,” McDowell says. Most states exempt a certain amount of assets from probate, so if your estate is small—less than $100,000, for example—you probably don't need a living trust. In addition, if most of your money is in retirement accounts, you may not need a living trust, because those assets will transfer to beneficiaries outside of probate. Life insurance with a named beneficiary won't go through probate, either, because the death benefit will go directly to the beneficiary.
You can also arrange to make bank and other accounts payable upon death to your heirs, in which case those accounts won't go through probate. Property owned jointly, such as a home owned by you and your spouse, will transfer to the surviving owner outside of probate, too.
Be wary of some myths about living trusts:
There are ways to reduce your federal and state estate taxes, but a living trust isn't one of them. If your estate is large enough to potentially expose you to estate taxes, consult with an estate-planning attorney about strategies to reduce the size of your estate.
The federal estate tax threshold is $12.06 million in 2022 ($24.12 million for a married couple), but unless Congress acts, the exemption will drop to $5.5 million in 2025. In addition, 12 states and the District of Columbia impose an estate tax, and some have much lower exemptions than the federal level.
It's unlikely that you'll include everything you own in your trust, and you may add assets between the time you draw up your living trust and your death. Your attorney will likely recommend a document known as a “pour over” will, which basically transfers to the trust anything you've excluded.
In addition to a will, you'll need other estate-planning basics, including a financial power of attorney and a health care proxy. If you have minor children, you'll also want to name a guardian. See below for a checklist of documents you should include in your estate plan.
Keep these estate-planning documents in a secure place, such as a home safe or safe-deposit box, and make sure your loved ones know where to find them. You may also want to give copies to your attorney and individuals who have been designated to play a role in your estate.
- Financial/durable power of attorney. This gives an individual the authority to manage your money if you become incapacitated.
- Medical power of attorney. This names an individual who is authorized to make health care decisions on your behalf if you're incapacitated.
- Directive to physicians/living will. This document allows you to specify the kinds of treatment and long-term care options you prefer.
- Funeral arrangements.
- Last will and testament.
- Any trusts you created, including your revocable living trust.
This article was provided by Sandra Block for Kiplinger Magazine, and brought to you by the Ronald J. Fichera Law Firm, where our mission is to provide trusted, professional legal services and strategic advice to assist our clients in their personal and business matters. Our firm is committed to delivering efficient and cost-effective legal services focusing on communication, responsiveness, and attention to detail. For more information about our services, contact us today!
This is not tax advice and should not be construed as such. Please seek professional tax services for more information and advice that will apply to your specific tax situation.
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