WHAT IS A LIVING TRUST, EXACTLY?
Much of the rest of this book will be about constructing a good living trust. But what is a living trust, exactly?
As I explained briefly earlier in the book, you can think of a living trust as a kind of vessel, a bucket which you create, and into which you place your stuff. Some things, like IRAs, 401(k)s, annuities and life insurance do not go into the trust, (See Mistake #5).
Basically, when your stuff goes into a bucket, it’s a lot easier for you to carry around, a lot easier to track, and a whole lot easier to pass on to another person. Forgive me for extending the metaphor, but if your stuff is not in a bucket, when you die, it falls onto the ground. Then other people have to find it, figure out who owned it, and go to court to prove it’s now theirs. Only then can they pick it up off the ground.
When you (or you and your spouse) create a living trust, you literally transfer many of the things you own into that trust. And while you are alive, you remain in control of that trust. When you die or become incapacitated, you give control of your trust to someone else. Because, according to law, the living trust owns all that stuff, and the trust survives you, no probate is required. There is nothing to prove to a judge. No “probate” needed. The trust continues to be the legal owner of the assets. Control of the trust simply passes to a new trustee.
As I also said in the Introduction, a living trust may sound like a legal fiction, but it is not. Living trusts are the very sensible way our society has devised to make succession easy, logical, and low cost. Trusts are the way we preserve legacies—a way of cheating some of the chaos created by death.
Every living trust includes at least three key roles. And while you are alive and of sound mind, you can play all three roles in the trust.
First, there’s the grantor. That’s the person (or jointly as a married couple) who creates the trust “bucket” and puts all their stuff into it. In the beginning, that would be you, or your parents, if you’re helping them get this done. Sometimes, other names are used for the grantor, such as the settlor, trustor, or trust maker, but it’s all the same idea. Attorneys prefer grantor, because that word has a specific meaning in our tax laws—the Internal Revenue Code.
Second, there’s the trustee. That’s the person (or couple) who controls the trust. Again, while the grantor is alive and well, that’s usually you.
Third, there’s the beneficiary. This is the person (or couple) who has a right to all the benefit of the stuff in the bucket.
While you are alive, this is definitely you.
Again, when you are alive and well, you generally play all three roles—that’s why it’s a living trust, because the trust protects you now, and continues to protect your estate when you are no longer able to protect it yourself. All your stuff is in the bucket, and as the grantor, when you get more stuff, you just add it to the bucket.
Need to pay your credit card bill? Your mortgage? Get some groceries? Buy a ticket to Hawaii? As trustee, you are the only one who can reach into the bucket and take stuff out for use by the beneficiary. You can do that as often as you like, because while you are alive, you are also the beneficiary.
Your kids go off to college? You write a check from the trust. Your daughter gets married? Paid from the trust.
You can treat the money in a trust completely as your own money, the house owned by the trust as your house, the car in the trust as your car—though again, in the eyes of the law, it all technically belongs to the trust.
HOW A LIVING TRUST PROTECTS YOU AND YOUR ESTATE
Now, what if you become so sick that you cannot exercise proper control over your assets? Without a trust, a lot of uncertainty and confusion attends disability. (See Mistake #8: Forgetting to Plan for Disability.)
With a trust, everyone knows exactly what will happen. Why? Because it’s written down. You will have designated someone else to take the role of trustee in your absence. Crucially, however, because you (or you and your spouse) remain the sole beneficiaries of the trust, the new trustee can only use your assets to take care of your needs: food, clothing, and mortgage payments, for example. In the event that you become capable of taking the trustee role again, the trust returns that power to you.
Here’s the key to avoiding probate: when you (or you and your spouse) pass away, the trust continues. It does not die with you. Only the names playing the roles change. There’s a new trustee and a new beneficiary, specified by you in the trust. And, presto! Your assets can be dealt with and passed on without any court or probate process required.
If Bob Sr. had created a living trust, placed all of his assets and accounts into that trust, and then named Bob Jr. as trustee when he died, well, our story would have had a very different ending.
On that first Monday morning when Bob Jr. showed up at Friendly Bank, he would only have needed to bring a copy of the signed trust, his father’s death certificate, and his photo ID. That’s it. The bank would have immediately given him control of his father’s accounts. Bob Jr. may also have had to get a “Taxpayer Identification Number (TIN)” from the IRS by submitting a form SS-4. The TIN belongs to the trust and functions like a Social Security number for the trust to deal with assets in the trust. Bob Jr. would not use his Social Security number, or that of his late father.
The manager would have said, “Terrific. You are now the trustee. You are in charge. We will change the name on the living trust account here at Friendly Bank, and starting today, you can sign the checks.”
That’s how simple the succession would have been. No published notices, no court dates, no legal fees, no judge, and no “form pleading.” Just an orderly passage of assets, generation to generation, in exactly the manner Bob Sr. would have desired.
Had minor children been involved, Bob Sr. could have designated a trustee to watch over the assets in his trust until those children were out of college. And in separate documents, as part of a complete estate plan, he could have nominated proper guardians for their well-being.
There’s more, of course. If Bob Sr. were a partner in a business, he could have used his estate plan to designate a trustee to take over his decision-making powers and business assets for the benefit of his estate and heirs. Maybe that trustee would have been Bob Jr. Or perhaps, it would have been a business associate he trusted, with Bob Jr. still being the beneficiary.
I hope you now understand why you must do whatever you can to protect your heirs from probate—and how a living trust will be critical to your plans.
Even with this understanding, however, it is imperative that you avoid making the mistake of assuming that all living trusts are more or less the same. Or, that they can be created with some cut-and-paste template.
In our next posts, we’ll look at the different kinds of living trusts, and how they must be custom-built for the complexities of modern families and modern life.
For more information on how to begin your living trust, contact our team today.