Issues to Consider for a Living Trust

When you write your living trust, make sure you consider these issues:

• Coordinated estate plan. It’s important to make sure to coordinate the trust with the rest of your estate plan. The executor of your will still must pay income and inheritance taxes and various probate expenses, but if too many of the estate assets are in the trust, he or she may not have enough money to do so. One way to meet this contingency is to give the trustee (and successor) power to make these payments from trust assets.

• Coordinated disability plan. Most lawyers will help you plan for your possible incapacity. Sometimes they’ll draft a durable power of attorney (see chapter 24) to go with the revocable trust, which will give the attorney in fact (person you’ve selected to act for you) the power to receive assets from and transfer assets to the trust in case you become incompetent. The conditions placed on the power will vary depending on your family and financial situation. In many, perhaps most, cases the attorney in fact will also be a co-trustee. Both are often your spouse, especially in smaller estates.

  However, when different people are carrying out those functions, lawyers caution not to give the attorney in fact actual control over the trust; in fact, they write that limitation into the power of attorney. The reason: it sets up a potential conflict of interest between one family member who’s charged with looking out for your benefit, and another, perhaps more distant, relative who stands to benefit from the trust. That person would have a vested interest in keeping more of the money in the trust, even though you might need it to pay for, say, a better nursing home.

  Finally, your lawyer will probably prepare and coordinate a living will or health care power of attorney (see chapters 24 and 25) with your living trust.

• One trust or two? Some lawyers say it works fine for a couple to use one living trust for all their shared property, whether in a community property state or common law state. Most couples prefer to keep ownership of important assets shared. That way, you don’t have to worry about dividing part-ownership of various assets (e.g., his 50% share of the house goes into his trust, hers into her trust). Nor, in the event of marital discord, does one spouse have to worry that the other’s trust owns their house.

  Such a joint marital trust will commonly provide that the property of the first spouse to die will go to the surviving spouse. Therefore, it winds up back in the living trust anyway, combined with the surviving spouse’s property. (When tax considerations come into play, this might change.)

  Remember that such a set-up transfers the property to the other spouse with no conditions of any kind. Also remember that in most states, divorce does not automatically invalidate a living trust. If you want to maintain more control over your property after you die, talk to your lawyer.

  But other lawyers disagree with the one-trust idea. If your lawyer doesn’t carefully arrange the joint trust, the couple might be exposed to the gift tax (see chapter 20). A joint marital trust can also cause estate tax problems and are not recommended if there are assets larger than the federal exemption amount.

  State laws vary in this area, so be sure to check with your lawyer before deciding whether to set up one trust or two.

• Revocable or irrevocable? As with other trusts, living trusts can be revocable (changeable) or irrevocable. Most living trusts are revocable. But some people (usually those with a lot of money) do use irrevocable living trusts to avoid taxes. You give up control over the assets in the trust, in return for escaping some estate, income or gift taxes. They’re often used to give money to charity (charitable remainder trusts). Other common irrevocable trusts are 2505c trusts, Crummy trusts, and life insurance trusts.

  An irrevocable trust doesn’t avoid taxes entirely--it merely sets up a separate taxable entity that might be able to pay taxes at a lower rate than if all the assets were combined in one estate. It can also offer a bit more protection from creditors.

Irrevocable Means No Do-Overs!

If you make the trust irrevocable to reduce taxes and avoid creditors, prepare for a lot of paperwork. And understand that you lose the flexibility of a revocable living trust. Be sure to consult a lawyer before setting up an irrevocable trust.

Funding the Living Trust

Setting up the trust is actually the easy part. The harder part is putting something in it--what’s called funding the trust. This includes not just depositing money in the trust account, but also transferring title of assets to the name of the trustee.