How Living Trusts Work

A living trust, (also called an intervivos trust) is an arrangement under which you transfer ownership of all or part of your property to a trustee during your lifetime. As the person establishing the trust, you name the trustee, who manages the property according to the terms of your written trust document. You may state in the trust agreement exactly what you want the trustee to do, how you much discretion you want to give your trustee. The trustee may be an individual or an institution or yourself.

The trust is for the benefit of one or more personal (including yourself if you wish), called the beneficiaries. A living trust is effective during your lifetime, although it may be written to continue beyond your lifetime.

Living trusts have lots of advantages. They enable you to avoid probate for the assets that are in the trust, are easy to create and change, and protect you privacy. In addition, trusts are more flexible than wills in that you don't have to give money and other property outright to your beneficiaries. For example, a trust can administer any assets given to minor children or grandchildren until they are old enough to manage them for themselves and administer assets for disabled relatives until their deaths. Moreover, trusts don't require active court supervision - you don't have to get a court's permission to buy or sell property, make distributions and so on.

Another advantage living trusts have over wills springs from the fact that they enable you to put property in trust while you are alive. This provides a simple and easy way for the property to be managed in the event that you are incapacitated. Thus a living trust may avoid the need to appoint a guardian of your estate if you should become disabled - your successor trustee can administer the property for you with no break in continuity and no need for expensive legal proceedings. You should designate in the trust document how the determination of you incapacity should be made - by examination and certification by your primary physician, or perhaps by examination by a larger number of physicians, including specialists, who must agree that you are incapacitated.

In this article, we take a quick look at the mechanics of setting up and administering a trust. Deciding whether a living trust is right for you depends on the size of your estate, what kinds of assets it contains, and what plans you have for yourself and your family. Your lawyer can advise you as to whether a living trust is best in your particular circumstances.

Setting up the Trust

When you set up a trust, you are called the Grantor or Settlor. Requirements for setting up a living trust vary with each state. In general, you need to execute a document saying that you're creating a trust to hold property for the benefit of your self and your family, or whomever you want it to benefit. The property can be any kinds of real or personal property - money, real estate, stocks, bonds, collections, business interests, personal possessions and automobiles. Some trust declaration list the major assets (home, investments) that you're putting in trust. Others refer to another document (a schedule) in which you list the exact property that will begin the trust.

In either case, you can add and subtract property whenever you want. You will have to change the ownership registration on whatever property you put into the trust - deeds, brokerage accounts, bank accounts, etc. - from your own name to the name of the trustee. If you make yourself the trustee, as most people do in setting up a living trust, you will have to transfer ownership from yourself as an individual to yourself as trustee. And you'll have to remember to sign yourself in transactions as "John A. Smith, Trustee," instead of using only your name.

The trustee has legal title to the trust property. But trustees are not the full owners of the property. Trustees have a legal duty to use the property as provided in the trust agreement and permitted by law. The beneficiaries retain what is known as equitable title or beneficial title, the right to benefit from the property as specified in the trust.

You can make anyone you want the trustee. You can also name an alternative trustee (someone known as the successor trustee) to take over in the event of the original trustee's death or incapacity.

Administering the Trust

Unless taxes are a worry - and they won't be in the vast majority of estates - you should be sure to retain the right to revoke or amend your trust whenever you wish. Have your lawyer create a revocable trust agreement, which allows you to change the terms or trustee or just end the trust altogether if it turns out to be too much trouble.

When you put property into a revocable living trust, the trustee becomes its owner, which is why you must transfer title to the property from your own name to that of the trustee. But whether you're the trustee or not, you retain the right to use and enjoy the property, and because you do, in the eyes of the tax authorities, the property in the trust belongs to you, the grantor, for tax purposes. If you receive income from the assets, you must still report the income from the trust directly on your income tax return. The trust itself often files a separate income tax statement as well, though the IRS doesn't require the trust to file separately if the grantor and trustee are the same person.

In a revocable living trust, you keep the right to manage your property whether you're the trustee or not, since you have a right to change the terms of the trust, the trustee, and the property in the trust at any time. When you die, your alternative trustee distributes the property according to the terms of the trust. Usually, your alternative trustee is your surviving spouse or an adult child, but you can name a bank or trust company if you are willing to pay their fees.

Living Trusts as Will Substitutes

It can't be a bother to set up and fund the living trust, but the payoff for your family comes when you die. If Ilsa wanted her property to go to her friend Rick, for example, she would put it in a trust and name him co-trustee or successor trustee. Then when she dies, he becomes sole trustee and acting in that capacity, transfers the trust property to the beneficiary - himself. The property does not have to go through probate, which will probably save both time and money.

Living trusts give you wide flexibility in distributing your property. For example, the trust agreement could say "at my death, my trustee is to give my car to my son, Cain, my cot to my son Jacob" and so on. Your instructions can tell the trustee to continue managing your assets for the benefit of someone else, distribute them to any beneficiaries you choose, or perform some combination of these actions.

If the beneficiaries of your living trust die before you do, what happens to the property depends on the terms of the trust and state law. For example, the property might revert to you or go to the deceased beneficiary's estate. To avoid confusion, make sure your trust clearly states what will happen under these circumstances, by naming one or more contingent beneficiaries for each gift.

A living trust can contain other, separate trusts, which gives you a nice flexibility. For example, if you plan to leave some of your property to your minor children in trust, you could specify in you trust that the children's property goes into a separate irrevocable children's trust. You can design separate trusts for several beneficiaries, all funded (usually at your death) by the assets in your living trust.