5 Key Steps to Creating a Living Trust

Considering a living trust? What about a will? Do you need both? 

There are many benefits to having a living trust but, as with any legal document, it requires careful planning. In this article, you'll learn exactly what a living trust is, and explore five basic steps you should consider when establishing your own living trust.

The basics

A living trust is a legal entity that can own property and direct distribution of that property after a person's death, or if they become incapacitated.

One of the primary benefits of a living trust is that it isn't subject to probate, or its associated costs and delays.

If you establish a trust, you (known as the grantor) appoint yourself as the initial trustee and primary beneficiary of the trust. You retain full and complete control over the property during your lifetime. In the living trust document, you appoint the individual(s) and/or entities that will take on the role as successor trustee when you can no longer act as the initial trustee. The trustee manages and distributes the trust assets according to the terms of the trust.

TERM: Probate When a person dies, the property from his estate can be transferred to the intended beneficiaries via a will. Probate is the process of properly transferring the estate to the rightful beneficiaries. This process is also used to collect any taxes due on the transfer of the property.

Does a living trust take the place of a will?

A living trust is sometimes referred to as a "will substitute." Although, in some respects, it does take the place of a will, a will is still usually necessary to distribute assets outside the trust, and to nominate guardians for minor children.

So why should you consider a living trust if you probably need a will, anyway? Because it only becomes effective at your death, a will does not avoid probate and does not protect you or the management of your assets in the event of your incapacity.

STEP 1: Identify your overall estate planning goals

Before you can determine if you need a living trust, you must first consider your overall estate planning goals. Your goals are unique and any trust you create should accurately reflect them. I find there are four reasons to consider a living trust: finances, probate avoidance, incapacity planning, and the ability to control assets after death.

Finances

A living trust lets your loved ones avoid the legal costs associated with probate. It can also reduce, or even eliminate, any estate tax liability by properly using your estate tax exemption amount to the fullest extent. The current federal estate tax rate is assessed against the estate (as opposed to your designated beneficiaries) based upon the net value of the property transferred at your death, less the applicable estate tax exemption amount.

Because we have an estate tax system (not an inheritance tax system) at the federal and state levels, the beneficiary doesn't pay taxes on the assets. Taxes may ultimately reduce the total amount the beneficiary receives, but the taxes don't come out of the beneficiary's pocket directly -- they are paid out of the estate before the beneficiary receives the property.

Probate avoidance

Avoiding probate is in many ways linked with financial motivations. However, aside from wanting to avoid the hefty legal fees that can come with probate administration, many people prefer to avoid probate so they can keep the distribution of their assets private. All information regarding your assets transferred through probate will become a matter of public record. Almost anyone, for almost any purpose, will be able to access this information.

Furthermore, probate can be a lengthy process (averaging a year or more in California, for example). So, if you want your beneficiaries to have access to your assets sooner, and without the need for court involvement or approval, a living trust might be a good option. Recall that a will by itself does not avoid probate.

Incapacity planning

As the average life expectancy continues to rise, so does the likelihood that at some point you'll become incapacitated. A will comes into effect only after your death. In contrast, the trustee of your living trust can take control of your assets during your lifetime.

A well-drafted living trust will include disability/incapacity planning provisions and is designed to work in conjunction with a Durable Power of Attorney.

Retained control after death

This benefit tends to be specific to the individual or family. A living trust lets you include further planning for minor children and for special assets and situations. You can also provide creditor and predator protection for surviving beneficiaries, which is difficult to accomplish through a standard will. For example:

  • Provisions establishing an inheritance protection trust, which can last for the lifetime of the beneficiary and prevent those assets intended for the beneficiary from being included in lawsuits against the beneficiary. An inheritance protection trust can also protect the assets from the beneficiary's spouse in the event of a divorce.
  • Provisions to protect the beneficiary from himself. As an example, these provisions might allow trustee discretion when the beneficiary has a drug or alcohol problem.
  • Provisions to create a special needs trust for any beneficiary who becomes disabled after the living trust has been executed, but before the trust assets are distributed. This would make certain that distributions to the special needs beneficiary would not make them ineligible for government assistance such as Social Security Death Index (SSDI) payments.
  • Provisions providing for your loved ones with fur, fins, or feathers (the appropriately termed pet trust or companion animal trust).
  • Provisions that protect the trust assets should the surviving spouse remarry.

STEP 2: Identify the parties involved

Perhaps the most important decisions to make when it comes to creating a living trust is the choice of your successor trustee(s) and beneficiaries. Usually, when someone is looking to establish a living trust, they have a general idea who they want to leave their assets to. However, when it comes to selecting the person (or entity) who will be responsible for distributing the assets, there isn't always an obvious choice.

Before executing a living trust, you should have a clear understanding of the powers and responsibilities you'll be granting the trustee. Administering a trust can be complicated and time-consuming for the trustee. You'll do yourself and your beneficiaries a disservice by selecting someone who isn't up to the challenge.

A successor trustee doesn't have to be a relative, but they must be someone you can trust completely. Family dynamics play an important role in the selection process, and you are the expert when it comes to your own family.

Blended families (e.g., second marriages, children from a previous relationship — think the Brady Bunch scenario), same-sex couples, or families with no children often have more difficulty in this stage of planning and are encouraged to seek legal counsel for guidance.

In many cases, a corporate trustee such as a trust company or a private fiduciary is the appropriate choice. Many financial firms and banks offer trust companies (for a fee, of course).

Your attorney can discuss the options with you, depending on what your personal situation is -- who you have available to act and if you have enough assets to warrant using a trust company.

STEP 3: Determine how to draft the document

There is a plethora of "do-it-yourself" trust-drafting software and online fill-in-the-blank solutions available for a fraction of the cost you'd pay for professional assistance. The drawback to these tools is that you're creating a binding legal document without obtaining any legal advice specific to your situation. In some instances, where there is a small estate and only one or two beneficiaries (who are not minor children), the do-it-yourself option may be worth considering.

TIP: I find many clients create do-it-yourself trusts only to visit an attorney later with the expectation that the attorney will correct any deficiencies in the document with a simple amendment. This usually doesn't work because most attorneys won't take on the liability of having their name attached to the original trust. Instead, the attorney will most likely require a complete restatement of the trust, which often costs the same as if you'd had the attorney draft the trust in the first place.

An alternative to the do-it-yourself method is to pay a few hundred dollars and use what is commonly called a "trust mill." Sometimes these trusts are prepared by paralegals, and sometimes they're prepared by what's referred to as certified document specialists. In any event, these individuals have not been qualified to interpret the laws relevant to property rights, taxes, wills, probate, and trusts in their state unless they've obtained a license from the State Bar. Using this type of service typically results in a do-it-yourself-quality document you paid someone else to do.

Many estate planning attorneys offer a low-cost or free initial consultation, and it makes sense to take advantage of this consultation to determine your next steps. If you're looking to hire an attorney to draft your living trust, you should select someone who devotes a significant portion (ideally all) of their practice to estate planning (wills, trusts, probate, trust administration, elder law). Although your up-front costs may be significantly higher by retaining a qualified attorney, the overall value they can bring will almost always save your estate money in the long run.

STEP 4: Funding the trust

A living trust only avoids probate to the extent that it is properly funded, i.e., that your trust includes as many of your assets as possible. If one of your motivations for creating a living trust is probate avoidance, you should make sure that the trust is funded with all your assets that would otherwise pass through probate. Typically, the critical asset to transfer into the living trust is any real estate you own. But you should also transfer your personal property, bank accounts, brokerage accounts, business interests, etc.

TIP: Transferring your primary residence into a living trust usually doesn't create a property tax reassessment, but you must file a preliminary change of ownership and the appropriate deed registering the transfer with the applicable county recorder. If you aren't sure about which type of deed you need to have recorded, consult legal counsel because the county recorder cannot offer you legal advice on this issue.

You can do most of the additional trust funding without professional help, but it often makes sense to have an attorney advise you regarding which assets should or should not be transferred and why. It is also a good idea to attach a Schedule A to your trust to identify all the property you intend to have transferred to the living trust.

STEP 5: Maintenance of the trust

Over time, there are going to be items you'll want to update or change with respect to your trust. Common events that should prompt you to review and revise your trust document include (but are not limited to): marriage, divorce, birth in the family, death in the family, purchase of new real estate, refinance of existing real estate, change in the tax laws relevant to your trust, and significant increases in your assets. In addition to these events, you should routinely review your document every three to five years. 

A gift to your family

Discussing death is never a pleasant aspect of financial planning, but it's certainly one of the most important. While no one likes to consider their mortality, properly planning will make a big difference for your family after you're gone. A living trust is just one of many important tools you should consider.

RESOURCES The California Bar Association publishes an excellent consumer pamphlet on living trusts. Information is available for free at www.calbar.org. For the specific laws governing trusts in California, see Division 9 of the California Probate Code §15000-19403. For further information on gift and estate Federal taxes, visit www.irs.gov.

A Good Start for Estate Planning

Your estate plan shouldn't end with the living trust, but rather begin there. At a minimum, your plan should include the following documents:

Pour-Over Will: This will directs that any assets you did not transfer to your living trust during your lifetime should be transferred to the trust and distributed according to the terms of your trust at your death. In addition, it should contain your nominations for guardians of any minor children in your care.

Durable Power of Attorney for financial purposes: This document authorizes your agent to transfer property to your trust and manage your financial affairs should you become unable to manage them yourself.

Power of Attorney for health care: Also referred to as a "Health Care Directive," this document authorizes your designated agent to make medical decisions on your behalf when you are not able to. This document should contain your directions regarding prolonging life by artificial means in the event you become diagnosed with a terminal condition.

HIPAA waiver: Under the Health Insurance Portability and Accountability Act of 1996 (HIPAA), hospitals, physicians, and other health care providers must take certain measures to protect patient information. A HIPAA waiver gives them permission to release your health information and medical records to people you designate.

Assignment to Trust of your personal property: This document funds your trust with your personal belongings such as your household furnishings, artwork, jewelry, etc. It establishes your clear intention that you want to have your personal belongings distributed according to the terms of your trust at death.

Certificate of Trust: This is a document you can give to financial institutions and others when they request a copy of your trust. It keeps the personal and financial information in your trust private.

TIP: Your living trust should include a provision authorizing the Certificate of Trust on the first page of the trust document. This way, when a financial institution requests the "authorizing language" of the trust, you only need to produce the first and last pages of the trust. Although it is beyond the scope of this article to go through these items in detail, it is important to know that these documents complement a living trust.

Kristine Kyllander is a California licensed attorney who devotes her practice to estate planning, probate, and trust administration. www.kyllanderlaw.com

steve
Can someone tell me in a neat sequence what are the steps to take in creating a living will? Who do I consult (ie., doctor, lawyer?)