Transferring Your Legacy
When Do Living Trusts Make Sense?
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 (and possibly update) after a major life change, such as the sale of your home, the birth of a child or grandchild, or a marriage or divorce.
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.
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.
The contents in this article are being provided for educational and informational purposes only. The information and comments are not the views or opinions of Union Bank, its subsidiaries or affiliates.