Question. Everywhere I go, I hear about the advantages of putting my house into a living trust. However, I do not understand how this works, and would like to learn more about this concept.
Answer. Living trusts are often "cocktail party" conversation pieces, and certainly should be considered by any taxpayer who is in the process of retirement planning. However, you must not jump into this concept hastily, and should explore all of the pros and cons, as well as other alternatives before establishing a living trust.
When property is put in trust, this means that in most cases legal title to the property is held by a trustee or trustees who are responsible for the maintenance and upkeep of that property for the ultimate beneficiary of the property. There are many kinds of trusts; the most common to which homeowners are familiar is a "deed of trust." This is the mortgage instrument, whereby the homeowner borrows money from a lender, and deeds the house in trust to a person or institution selected by the lender. If the borrower pays the money in full, the trustee releases the trust; if the borrower becomes delinquent, the trustee exercises its powers to sell the property at a "trustee's" foreclosure sale.
A testamentary trust is established by an individual's Will, and comes into being on the death of that individual. Many people will consider placing their property in trust on their death if, for example, their children are young, and they want to make sure the children can continue to stay in the house under the supervision of a trustee and a guardian. In this example, often the trust will end when the children reach a certain age. Under such a testamentary trust, the terms of the trust must be spelled out to assure that the trustee fully understands his or her role.
As with every trust, the trustee has a fiduciary responsibility to the beneficiary, and cannot squander or steal the trust assets.
A living trust is created while the homeowner is alive. This is often called an "inter vivos" trust, which is Latin for "between the living." This must be a revocable trust, which means the individual creating the trust has the right to change its terms or cancel the trust entirely at any time, for any reason, during his or her lifetime.
The primary reason for establishing a living trust is to avoid probate proceedings. The person who creates the trust is called the "grantor." Under state laws, the trust -- and not the grantor -- owns the property. Title to the property is transferred from the grantor to the trustee, and as we have indicated, the trustee holds the property for the benefit of the beneficiaries who are named by the grantor.
Much bas been written about the problems and pitfalls of the probate process .There is no question that probate, in many states throughout this country, is a time-consuming, costly, and onerous process. Insofar as ownership of property in a revocable living trust is in the trust, when the grantor of the property dies, the property does not have to be probated, since it is no longer within that decedent's estate.
Thus, this is a very significant reason for creating a living trust.
But there are other advantages to a living trust. For example, if the homeowner owns property in more than one state, on the death of that homeowner, probate proceedings must take place in each state where property is located. These are usually referred to as "ancillary proceedings." Clearly, if property is held in a living trust, it is outside of the estate of the decedent, and thus ancillary proceedings are not necessary.
Another advantage is privacy. Probate is a matter of public record, whereas living trusts are private. Some individuals may not want to disclose who their ultimate beneficiaries will be, and the living trust provides a modicum of privacy.
However, there are many pitfalls in the use of the living trust.
Although we have indicated that for ownership purposes, the trust -- and not the grantor -- is the legal title owner of the property, for tax purposes, the property in a trust remains the property of the grantor. Contrary to popular opinion, living trusts do not save estate taxes, and they do not save income taxes.
More importantly, there may be increased costs as a result of the creation of such a living trust. Legal fees, administrative costs of distributing assets, and the paperwork that the trust has to handle may be as much of a burden as having to go through the probate proceedings. It is important to understand that before the trust can be effective, you have to prepare a deed and convey the house to your new trust.
More importantly, even if the homeowner sets up a living trust, that individual must still have a Will. Most people own more than their house, and when there are children involved, and other assets, it is imperative to have a Will to make clear your intentions as to how your property will be disposed of on your death. With a Will, even if there is a cumbersome probate proceeding, at least your intentions have been made known; without a Will, the Judge will have to make an educated guess as to how you would have wanted your property to be distributed.
Living trusts are an option to be considered during for your retirement planning. However, you must do a complete asset check to determine how serious your estate will be impacted by the probate proceedings. For example, other assets may already be probate proof, such as life insurance proceeds, IRAs, or other retirement benefits.
Everyone must consult his or her tax and financial advisors before making any precipitous moves.