How To Use a Living Trust To Protect Inheritances
A wealth management strategy that keeps assets in the family
Last Updated: September 12, 2023
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Key Takeaways:
- A Living Trust is a valuable estate planning tool for managing businesses, real estate, and high-valued assets. It's also beneficial for those with straightforward estates.
- Living Trusts help avoid probate, ensuring a quick and private transfer of wealth upon the grantor's death.
- Combining a Living Trust with a Pour-Over Will ensures all assets are properly managed and distributed according to the grantor's wishes.
You work hard to create a business and grow your wealth.
Justifiably, you’ll want to do everything possible to ensure your legacy goes where you want it when you’re gone.
Sure, a Last Will and Testament carries out many goals. But do you know how to use a Living Trust to protect your high-valued assets and property?
Trusts are legal entities that hold assets for beneficiaries to eventually inherit. Learn how this estate planning document helps guarantee your loved ones benefit from your life’s achievements as you’d intend them to.
When is a Living Trust a good idea?
Certainly, a Living Trust is a valuable estate-planning tool for managing businesses, real estate, and high-valued assets/accounts.
But it’s not just for wealthy individuals.
Unlike a Last Will and Testament, a Living Trust avoids probate (which can take months or even years). So it’s a helpful strategy for arranging a quick and private transfer of wealth when you pass away.
If you have a sizable but straightforward estate, it’s easily possible (and smart) to write instructions for the management of your assets and property in a Living Trust.
Plus, you can name a trustee—someone to represent and enforce your intentions while you’re living and after you’re gone.
In essence, a Living Trust is a good idea when you want to
- Quickly transfer estate assets to your beneficiaries after you die
- Prevent people from using your assets against your wishes
- Benefit from tax exemptions
- Protect your privacy
Although we’ll cover the basics of Living Trusts, you can always consult a lawyer to learn more.
Revocable vs Irrevocable Living Trusts
Generally, there are two types of Living Trusts: revocable and irrevocable. The type that works best for you depends on your situation and what you want to do with your estate.
In any case, once you create a Living Trust, you become its grantor.
Revocable Living Trust
With a Revocable Living Trust, you can appoint yourself as a trustee and change the terms of your trust at any point in your lifetime.
That being said, you’ll need to be organized and diligent about updating a revocable trust as things change in your life. Or, you could always hire a professional to help.
Unfortunately, retaining control over the trust during your lifetime means any creditors or interested third parties might have the opportunity to claim your assets.
Still, the flexibility of a Revocable Living Trust is beneficial when adapting your estate plan to life changes. You’ll also gain peace of mind having someone to manage the trust on your behalf, in case you ever become incapacitated.
Once you die, however, your successor trustee takes over and the terms of the trust become irrevocable.
Irrevocable Living Trust
As the name implies, you generally can’t change the terms of an irrevocable trust once you enact it. As such, it’s crucial to have a trustee that’s honest, responsible, and capable of executing your wishes.
How is a Living Trust taxed?
It’s important to acknowledge the tax implications of a Living Trust, as different rules and regulations may apply depending on where you live and the type of trust you have. (That said, it makes sense to ask an accountant if you have specific questions.)
In general though, here’s what you should know about simple trusts and taxes.
While you’re alive, you must report trust earnings on your personal income tax report. This is because the Internal Revenue Service (IRS) considers trusts to be disregarded entities—which means they’re not separate from their owners. However, any gifts that you transfer into the trust typically won’t be subject to gift taxes because the IRS views the gift as incomplete.
Once you pass away, governments include your trust as part of your estate. As such, your executor will need to add your trust property to the total value of your estate when calculating how much tax your estate must pay. They’ll also need to include any trust earnings from that year on your final income tax return.
After the grantor’s death, the Living Trust becomes an irrevocable separate entity and is responsible for its own income tax. In this case, tax obligations vary depending on the situation.
Can a Living Trust be contested?
Yes, it’s possible for someone to contest your trust in court—but they’ll need legal grounds to do so.
Generally, a person can only challenge a Living Trust if they believe it’s void, voidable, or the trustee breaches their fiduciary duty. For example, common reasons to contest a trust include undue influence, lack of capacity, or fraud.
The privacy of a Living Trust can help it avoid legal challenges. Unlike with a Will, most states don’t legally require you to register your trust to the public record. So, you only really need to inform the people that the trust impacts directly. This includes:
- Your trustee, co-trustee (if any), and successor trustee
- Hired professionals (e.g., your accountant or lawyer)
- Beneficiaries
Creating a Living Trust for your children
Sometimes, kids aren’t ready for a large or sudden inheritance—whether they’re minors or young adults. As such, the extent of control you’ll have over your kids’ inheritance is what makes a Living Trust a valuable tool in your estate plan.
If you die before your kids become legal adults, their new legal guardians will likely gain control of their inheritance. Although you might set aside funds for your kids’ cost of living, you may be reluctant to hand over your life’s savings all at once.
Similarly, you might hesitate to give a large sum of money to a 19- or 20-year-old. Imagine how quickly a young adult might spend their inheritance on frivolous items or an exuberant lifestyle. For these reasons, a dependable trustee can be crucial for proper money management.
With a Living Trust, parents can control not only what each child receives but also when (i.e., a delayed inheritance) and why (e.g., after life events such as graduating, getting married, or having a child).
What’s more, you can direct your trustee on how to use the trust (e.g., directly paying for school or healthcare) rather than giving your beneficiary the freedom to spend the money on whatever.
On the other hand, you could specify annual distributions to establish a reliable income or distribute varying amounts over time. For instance, you might allow them to inherit a small amount at first, but then grant access to the remainder of the inheritance once they reach a certain age.
Another option is to give the trustee power to use their discretion when deciding when the kids get money and/or how much they get at a time.
LawDepot's Revocable Living Trust template automatically includes a term for discretionary power. If you use our template and want to add more detailed instructions, it's best practice to get a legal professional review your document to ensure it reflects your wishes accurately.
Protecting the inheritance from other claimants
A Living Trust can offer some protection to an inheritance if your beneficiaries claim bankruptcy, get divorced, or are involved in a legal battle.
As long as the inheritance remains in the trust, no one should be able to make a claim against them.
In other words, these assets are held in trust for the beneficiary to inherit at a later point in time. Therefore, claimants typically can’t pursue these assets because they don’t belong to the beneficiary yet.
However, claimants may go after any distributions that the beneficiary receives. Thankfully, some state laws protect the amount that creditors may garnish from a trust. As such, it’s important to understand how your local laws govern Living Trusts.
How a Living Trust and a Pour-Over-Will work together
Creating a Living Trust doesn’t mean you can’t or shouldn’t create a Last Will. But it does mean that your Will might look a bit different.
A Pour-Over Will is a special type of Last Will and Testament that works together with a Living Trust. This document transfers—or pours—any missed property into your Living Trust when you pass away.
Basically, having this type of Will helps you cover all your bases and prevents any applicable property from being left out of your Living Trust.
It’s simpler than a normal Will, since it excludes detailed instructions for property distribution. However, this estate-planning document allows you to leave instructions typically left out of a Living Trust:
- Name an executor to carry out the wishes written in your Will
- Appoint a guardian for any minor or dependent children
Since a Pour-Over Will catches any property that wasn’t included in a Living Trust, it works as an excellent backup plan. That extra layer of protection in your estate plans can give you peace of mind.
With these two documents, your executor and trustees can handle your estate according to your wishes even in the event of an oversight or mistake.
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