How Do Living Trusts Work?

by Team eLocal
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Reviewed by Carina Jenkins, J.D.

If you're thinking about your estate planning arrangements, a living trust could be worth considering.

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Let's explore what a living trust is, how it works and whether it's a suitable option for you.

What Is a Living Trust?

A living trust is a financial tool whereby a trustee manages the owner's assets on behalf of a beneficiary. The owner of the assets is known as the settlor. Unlike testamentary trusts, a living trust becomes active when you make it, instead of after your death. As a living trust is active during your lifetime, you can choose to act as the settlor, trustee and beneficiary simultaneously.

What's the Difference Between a Living Trust and a Living Will?

While they sound similar, a living will is entirely different from a living trust. Instead of leaving assets to your beneficiaries, a living will outlines what medical interventions you wish to receive if you become critically ill. The purpose of a living will is to allow you to consent (or deny consent) to medical treatments in advance. A living will states your preferences about life support and other care in case you're unconscious or unable to make decisions for yourself in the future.

Both living wills and living trusts apply from the time you formalize them. However, a living will becomes void when you pass away, while a living trust lasts until the trustee has distributed your assets according to your instructions.

How Do Living Trusts Work?

You can set up a living trust yourself. However, this can be complex, so it's often best to ask a lawyer to help you create a watertight trust document using the correct legal wording. Once you've executed the document, your chosen assets become part of the trust.

Most living trusts are revocable, meaning you can dissolve the trust at any time and manage the assets as you see fit. These trusts usually only become irrevocable if you pass away or lose the capacity to manage your finances. However, sometimes it makes sense to establish an irrevocable living trust, which means you can't dissolve the trust once established.

When you set up a living trust, you must name one or more trustees. The trustee is the person who manages the assets until the time comes to distribute them. The person setting up the living will may act as the trustee, but it's important to name at least one backup trustee to manage the trust after your death or when you can't manage it yourself.

You must also name a beneficiary to the trust. The beneficiary is the person who will inherit your assets. Often, the settlor names themselves as the beneficiary of a living trust. However, you should also pick backup beneficiaries to inherit assets held in the trust after your death.

After you die, your trustee will distribute your assets according to your instructions. Alternatively, the trustee may continue to manage your assets for a longer period if you instructed them not to distribute them immediately. For example, you may wish the trustee to distribute the assets when a minor beneficiary reaches adulthood or over an extended period to prevent your beneficiary from spending the funds too quickly.

If you lose the capacity to manage the trust, your trustee will oversee your assets on your behalf. Their duties could include making investment decisions, managing real estate property and spending funds in your best interests.

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Are There Different Types of Living Trusts?

Although most living trusts are revocable, you can also set up irrevocable living trusts. This type of living trust is more unusual, but it may reduce the amount of your estate liable for estate tax or protect your assets from your creditors. However, the disadvantage of an irrevocable living trust is that you can't access the funds during your lifetime or change the terms.

Therefore, it may not be the best option if you think your circumstances may change. For example, an irrevocable trust could cause issues later if you have another child, as you won't be able to add them to the list of beneficiaries.

Who Should Have a Living Trust?

There are several reasons for setting up a living trust. A living trust could be the most appropriate estate planning option if one of these situations applies to you:

You Want to Avoid Probate

Any assets in a living trust aren't considered part of your estate, so they won't go through probate after your death. A living trust allows your trustee to distribute your assets without permission from the probate court, affording swifter access for your beneficiaries.

You Want Protection From Creditors

Creating a revocable living trust won't prevent creditors from going after your assets during your lifetime. However, it could protect your assets from creditors after your death. Depending on your state, an irrevocable living trust may offer some protection from creditors.

You Would Benefit From Estate Tax Reduction

Typically, a living trust can reduce the estate tax your beneficiaries must pay after you die. However, estate tax rules can be complex, so it's worth consulting a financial professional with expertise in estate planning to discuss the potential tax implications.

You Want Privacy

Unlike living trusts, wills become public record after probate concludes. You may prefer to create a living trust if you don't want to allow free access to your financial information after you die.

You Have Complex Distribution Instructions

Generally, trusts (including living trusts) give you more control over the distribution of your assets than leaving them to your beneficiaries in your will. For example, you can often provide instructions for when and how your beneficiaries may access and spend the money after you pass away.

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