What is a living trust?
A living trust is a legal document, or trust, created during the life of an individual where a designated person, the trustee, is responsible for managing the assets of that individual for the benefit of the prospective beneficiary. A living trust is designed to allow easy transfer of the assets of the creator of the trust or the settlor while bypassing the often complex and costly legal process of probate. Living trust agreements designate a trustee who legally owns the assets and property that go into the trust.
Key points to remember
- A living trust designates a trustee to manage the assets for the beneficiary, while the settlor is still alive.
- Trustees with a fiduciary duty manage trusts according to the best interests of the beneficiary.
- Living trusts can be irrevocable or revocable.
How Living Trusts Work
Living trusts are managed by a trustee who generally has a fiduciary duty to manage the trust prudently in the best interests of the beneficiary of the trust or beneficiaries designated by the settlor of the trust, also called the settlor. On the death of the settlor, these assets are transferred to the beneficiaries in accordance with the wishes of the settlor, as indicated in the trust agreement. Unlike a will, however, a living trust is in effect as long as the settlor is alive and the trust does not have to go to court to reach its intended beneficiaries when the settlor dies or becomes incapacitated.
Types of Living Trusts
Living trusts can be irrevocable or revocable. With a revocable living trust, the settlor of the trust can designate himself as trustee and take control of the assets within the trust. However, this stipulation means that the assets of the trust remain part of the estate of the settlor of the trust, which means that the individual may still be liable for inheritance tax if the estate is assessed beyond the exemption from the estate tax at the time of death. The settlor of the trust also has the power to change and amend the trust rules at any time. This means that the settlor of the trust is free to change the beneficiary or to cancel the trust entirely.
With an irrevocable living trust, the settlor waives certain rights of control over the trust. The trustee effectively becomes the legal owner, but the individual would also reduce his taxable estate. Once the trust agreement for an irrevocable living trust has been concluded, the named beneficiaries are defined and the settlor can do little to modify this agreement.
Sale of assets in living trusts
A living trust itself can be named the beneficiary of certain assets that would otherwise go directly to the named beneficiary, regardless of what is stated in a will. These include employer sponsored retirement accounts such as 401 (K), individual retirement accounts (IRA), life insurance policies and certain bank accounts such as accounts payable upon death (POD). Living trusts may include accounts held in trust, which are created during the settlor’s lifetime and which are not established at death, as stated in a will and will.