What Is a Living Trust and How Does It Work?

Most people know they should have a will (whether they actually have one is a different story). But for those who do take the step of drafting a will, they often don’t realize there’s an alternative that could potentially work even better for them – a living trust.

WHAT IS A LIVING TRUST?

In estate planning, the terms “living trust” and “revocable trust” are used interchangeably and sometimes even “revocable living trust” makes an appearance.

Living trusts are created as an alternative way to control how your assets are distributed at death, because they’re more private and efficient than a will. While the trust is created while you’re alive (and, if you do it right, your assets are afterwards owned by the trust instead of by you directly), you generally don’t give up any control over your money and property, because you initially name yourself as trustee (the person who manages the assets) and beneficiary (the person who benefits from them).

You also retain the right to amend the trust in any way, or to revoke it and take all your assets back.

This article will refer to a trust that can be amended or revoked by someone as a living trust (but to call it a revocable trust would also be correct, and you’ll find that many advisors and estate planning attorneys will use the term “revocable trust” more often than not).

HOW DOES A LIVING TRUST WORK?

All trusts have a grantor (the person who creates and funds the trust), at least one trustee (who manages the trust) and at least one beneficiary (on whose behalf the trust is managed).

With a living trust, as we said, you’ll generally name yourself as the trustee and beneficiary initially. But you’ll also name at least one successor trustee and at least one beneficiary to inherit the assets when you’re gone.

The successor trustee will take over management of the trust after you either die or become incapacitated (unable to manage it). They’ll ultimately be responsible for distributing your assets much like an executor would with a will.

The beneficiary is the person (or people) that you want your assets to go to after you die. It can be and often is the same person as the successor trustee. For example, you may name your child (or children) as the successor trustee and beneficiary.

An important note: Setting up your trust is only the first step. If you don’t move your assets into it, it’s useless. Right after setting up your trust, your estate attorney should help you move any property into the trust and guide you on how to retitle financial accounts, which is usually a simple process.

After you do that, nothing much happens until you die. But as with the rest of your estate plan, you should check in on a regular basis or whenever life changes, just to make sure it still aligns with your wishes. Remember, you can make any updates you want while you’re alive.

REVOCABLE LIVING TRUST VS. IRREVOCABLE TRUST

A revocable living trust is quite different from an irrevocable trust, which can’t be revoked or easily altered once it’s set up.

The purpose of a revocable trust is to streamline estate settlement and gain privacy for your family. During your lifetime, you maintain full ownership and full control.

An irrevocable trust, on the other hand, is an entity by which an individual inherits wealth or receives a gift. Irrevocable trusts are often created for family members with special needs or for individuals needing to plan around estate taxes. 

LIVING TRUST VS. WILL

Both a living trust and a will are used to direct the distribution of your assets when you’re gone, and both can be easily changed or revoked while you’re alive. But a living trust can streamline the estate settlement process, avoid the costs of probate and keep your estate’s distribution private. A will, on the other hand, is subject to a probate proceeding (which makes details of your estate public and potentially slower and more expensive).

A will, however, is the only document for naming guardians for any minor children you have – so if that’s your situation, you still need a will, even with a living trust.

And either way, a living trust also requires a companion “pour-over will” that ensures all assets make it into your trust even if you miss something.

DO LIVING TRUSTS AVOID PROBATE?

Potentially. The main benefit of a living trust is that your successor trustee (whose role is similar to that of an executor) has access to the assets within the trust without the need to first probate your will. 

Avoiding probate also means the terms of the trust remain private (a will would be entered into the public court record) and that probate costs, which can be substantial for large estates, are avoided.

As noted above, even if you have a living trust, your probate-subject assets won’t avoid probate if they’re not actually held in the name of the trust. That’s why that second step of retitling assets is so important.

BENEFITS OF A LIVING TRUST

A living trust can potentially benefit everyone involved in your estate plan:

• It can make things easier for your successor trustee when you pass, because again, the transition can happen without delay – no need to wait for a formal court acceptance of the will and designation of the executor
• For your beneficiaries, bypassing probate can give your family more privacy at a difficult time, potentially reducing the costs charged to the estate (and increasing their inheritance)

LIVING TRUST EXAMPLE

Knowing the living trust definition is one thing. Here’s a real-life example.

Let’s say you and your estate planning attorney decide a living trust makes sense for you. (For simplicity’s sake, we’ll imagine you’re unmarried and your two children are your planned heirs.) You and your attorney work together to draft and execute the trust agreement. Then they’ll help you move the appropriate assets into it by changing ownership to the trust’s name instead of yours.

As time goes by, you monitor and make updates as needed – in this example, let’s say your updates include adding grandchildren as beneficiaries as they’re born, and removing one child as a successor trustee at their request (they’ve moved overseas and it’s just not practical). You’re also careful to title your new home in the name of the trust when you downsize, as well as an investment account you open later on.

When you pass away, your remaining successor trustee steps in right away, without waiting for the probate process. That means they can immediately pay any bills owed by your estate, access your home to secure it and your property, and start the process of taking control of financial accounts. And bypassing probate also means the estate won’t have to pay probate costs and that the terms of your estate’s distribution will remain private.

WHEN A LIVING TRUST IS COMMONLY USED

Many people could benefit from a living trust, unless you have a very simple distribution plan (everything going to a single beneficiary, for example) or all your assets are those which wouldn’t be subject to probate anyway (for example, life insurance, retirement accounts and jointly owned accounts and property).

They can be especially helpful for:

• Property owners with real estate in multiple states
• Blended families or complex family situations
• Complicated assets, like a business
• States where probate is exceptionally burdensome

INTEGRATING A LIVING TRUST INTO A BROADER FINANCIAL STRATEGY

A living trust needs to be aligned with your overall estate planning, including designations (guardian, power of attorney, health care proxy), beneficiaries and asset and account titles.

And your estate plan should align with your financial plan, so your money can work hard for you now and for your future beneficiaries later.