Funding a Living Trust

These days many people choose an estate plan that includes a revocable living trust (RLT) instead of relying solely on a will, joint ownership, or beneficiary designations as their estate plan. They like the cost and time savings, plus the added control over assets that an RLT can provide in the event of their incapacity and death.

For example, when properly prepared and funded, an RLT can avoid the public, costly, and time-consuming court processes at death (probate) and incapacity (conservatorship or guardianship). It can let you provide for your spouse during your spouse’s lifetime and for your children after your spouse’s death, which can be important in second marriages. It can defer or reduce estate taxes. And it can protect inheritances from court interference, creditors, spouses, divorce proceedings, and irresponsible spending.

Still, many people make a big mistake that sends their assets right into the court system: they do not fund their trusts.

What is “funding” my trust?

Funding your trust is the process of transferring your assets from you to your trust. To do this, you physically change the titles of your assets from your individual name to the name of your trust. If you are married, you and your spouse might change the titles of your jointly owned assets to your joint trust or to each of your individual trusts, whether in equal or unequal portions.

You may not be able to transfer all of your assets to your trust. For example, retirement plans such as individual retirement accounts (IRAs) cannot be owned by your trust while you are living. However, you can change the beneficiary designation for your IRA to your trust as primary or contingent beneficiary to receive retirement benefits after your death.

Who controls the assets in my trust?

The trustee you name will control the assets in your trust. Most likely, you have named yourself as trustee initially, so you will still have complete control during your life. One of the key benefits of an RLT is that, as trustee, you can continue to use, invest, buy, and sell trust assets just as you do now. You can also remove assets from your RLT should you ever decide to do so.

Why is funding my trust so important?

If you have signed your trust agreement but have not changed titles and beneficiary designations, you are unlikely to avoid probate. Your trust agreement and trustee can only immediately control the assets you have put into the trust. You may have a great trust, but until you fund it (transfer your assets to it by changing titles or provide for transfer by beneficiary designation), it does not control anything. If your goal in having an RLT is to avoid probate at death and court involvement at incapacity, then you must fund it now, while you are able to do so.

What happens if I forget to transfer an asset?

Along with your trust, your attorney will prepare a pour-over will that acts like a safety net. When you die, the will catches any forgotten asset and sends it to your trust. The asset will likely go through probate first, but then it can be distributed according to the instructions in your trust.

Who is responsible for funding my trust?

You are ultimately responsible for making sure all appropriate assets are transferred to your trust either by changing the title to transfer the assets now or updating the beneficiary designation to arrange for the assets’ transfer later.

Will my attorney do this?

You may transfer some assets and your attorney may handle the transfer of others. An attorney will likely need to be involved in transferring real estate and completing more complex beneficiary designations, but then provide you with instructions for transferring your other assets, such as bank accounts. Ideally, your attorney will review each asset with you and determine what steps need to be taken and who will be responsible for each step. If you have a good understanding of the process, you may decide to handle many of your assets yourself. However, saving on legal fees should not stop you from involving your attorney as needed to ensure that assets are properly transferred and beneficiary designations are properly completed.

How difficult is the funding process?

It is not difficult, but it will take some time. Title changes for bank accounts and updating beneficiary designations may be as easy as visiting the relevant financial institution and signing paperwork whereas changing the title to a piece of real estate often requires the preparation and recording of a new deed in the county property records. For other assets, such as personal property and certain business interests, a document assigning the interest may be used. Many steps in the funding process can be handled by mail or telephone.

Some financial institutions or other entities will want to see proof that your trust exists. To satisfy them and keep your trust agreement private, your attorney will prepare what is often called a certificate of trust. This is a legal document that verifies your trust’s existence, explains the powers given to the trustee and identifies the trustees, but it does not reveal any information about your beneficiaries or your assets or their disposition.

While the process is not difficult, it is easy to get sidetracked or procrastinate. It is important to make funding your trust a priority. One approach is to make a list of your assets, their values and locations, then start with the most valuable ones and work your way down. Keep in mind the purpose of this process, and look forward to the peace of mind you will have when the funding of your trust is complete.

Which assets should I put in my trust?

Generally, all of your assets should be in your trust. However, as we will explain, there are a few assets that you may not want, or that cannot be put into, your trust. Also, your attorney may have a valid reason (like avoiding a potential lawsuit) for leaving a certain asset out of your trust.

Typically, assets you want in your trust include real estate, bank and investment accounts, business interests, and notes payable to you. You will also want to update most beneficiary designations to name your trust as a primary or contingent beneficiary.

Will putting real estate in my trust cause any inconveniences?

In most cases, you will notice little difference. As discussed above, you may transfer your real estate interests to your RLT, purchase new real estate in the name of your trust, and sell real estate owned by your trust.

Before transferring any real estate that has an associated mortgage to your trust, you may need to first obtain approval from your lender. This is because mortgage documents often contain a due-on-sale or -transfer clause. You and your RLT are essentially the same for tax and other purposes, so retitling the property in the name of your trust with lender approval should not activate this clause. In addition, there should be no effect on your property taxes because the transfer should not cause your property to be reappraised. Finally, having your home in your trust should have no effect on your being able to use the capital gains tax exemption when you sell it.

You should contact your homeowner, liability, and title insurance providers to update the property owner to your trust, which may make it easier for a successor trustee to conduct business for you.

What about out-of-state property?

If you own property in another state, transferring it to your RLT will prevent a guardianship or probate in that state. Your attorney can contact a title company or an attorney licensed in that state to handle the transfer for you.

What about contaminated property?

Property that has been contaminated (for example, from a gas station with underground tanks or by a printing facility that used chemicals) can be transferred to your RLT, but doing so can create liability to the trust and the trustee. If you are your own trustee, this is a moot point because, as the owner, you are already responsible for any environmental cleanup, compliance, or assessment. But if these environmental issues are not eventually resolved, your successor trustee and, ultimately, your beneficiaries can also be liable. In addition, the trust assets may be diminished or otherwise jeopardized by these efforts. If you suspect this may apply to you, tell your attorney before you transfer the property to your trust.

What about community property?

Community property status can be preserved inside your RLT. You should inform your attorney if you ever lived in a community property state (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin, or by opting into community property law treatment in Alaska), as your attorney may have estate planning recommendations specific to your community property assets that have important tax consequences.

What about my life insurance?

That depends on the size of your estate. Federal estate taxes must be paid if the net value of your estate when you die is more than the amount exempt at that time. Some states have their own estate and inheritance taxes, and it is possible your estate could be exempt from federal tax but have to pay state tax.

Your taxable estate includes the value of proceeds from life insurance policies you can borrow against, assign or cancel, or for which you can revoke an assignment, or name or change a beneficiary.

If your estate will not have to pay estate taxes, naming your RLT as owner and beneficiary of the policies will give your trustee maximum control over the policies and the proceeds.

If your estate will be subject to estate taxes, it is often better to set up an irrevocable life insurance trust (ILIT) and have it own the policies. The ILIT’s ownership of the policies will remove the value of the policy proceeds from your estate, reduce estate taxes, and let you leave more to your loved ones. Ideally, the trustee of the ILIT will purchase and own any policy from the outset. There are some additional considerations when transferring existing policies to an ILIT. The transfer of a policy will be either a gift, a sale, or part-gift and part-sale. If you die within three years of the transfer date, the IRS will consider the transfer invalid and the policies will be back in your estate.

You should discuss with your attorney the best way to handle your existing and new life insurance policies.

What about my car?

Generally, cars and other motor vehicles should not be transferred to your trust. Trust ownership can sometimes cause issues with your insurance premiums and coverage. In addition, if you are involved in an accident, the injured party may see that your car is owned by a trust, think “deep pockets”, and be more likely to sue you. Certain exceptions to this general rule include high value motor vehicles, boats, or planes.

Some states allow cars specifically or assets under a certain value to transfer outside of probate (the value of your car may be within this limit). Your attorney will be able to advise you on how to handle your car’s transfer under your state’s laws and procedures.

What about my IRA and other tax-deferred plans?

Do not change the ownership of these to your RLT. The Internal Revenue Service considers that changing the owner of your IRA or 401(k) even to the name of your trust is a 100 percent withdrawal from the account. You can name your trust as the beneficiary, but be sure to consider all your options, which could include your spouse; children, grandchildren, or other individuals; a trust; a charity; or a combination of these. Whom you name as beneficiary will determine the amount of tax-deferred growth that can continue on this money after you die, so you should discuss these options with your attorney or tax professional before completing any beneficiary designation.

Many married couples name their spouse as beneficiary because 1. the money will be available to provide for the surviving spouse and 2. the spousal rollover option can provide for many more years of tax-deferred growth. (After you die, your spouse can roll over your tax-deferred account into the spouse’s own IRA and name a new beneficiary, preferably someone much younger, such as your children or grandchildren.)

Of course, any time you name an individual as beneficiary, you lose control. After you die, the beneficiary can do whatever he or she wants with this money, including cashing out the account and destroying your carefully made plans for long-term, tax-deferred growth. The money could also be available to creditors, spouses and ex-spouses, and there is the risk of court involvement at incapacity.

Naming a trust as beneficiary will give you maximum control because the distributions will be paid not to an individual, but into a trust that contains your written instructions stating who will receive this money and when, with some restrictions.

The rules for these plans are complex, and it is easy to make a costly mistake. Because there is often a lot of money at risk, be sure to consult your attorney or tax professional.

Are there any assets I should not put in my trust?

If you live in a non–community property state and have owned an asset jointly owned with your spouse since before 1976, transferring the asset to your RLT could cause your surviving spouse to pay more in capital gains tax if he or she decides to sell the asset after you die.

If the asset is your personal residence, this would not be an issue unless the gain is more than $500,000. But it could be a problem for other assets like farm land, commercial real estate, or stocks. This is why it is important to check with your tax advisor or attorney before you change the title to your trust.

Other assets that should probably not be transferred to your trust are incentive stock options, Section 1244 stock and professional corporations. If you are unsure whether or not to transfer an asset to your trust, check with your attorney.

What about property that does not have a title?

Personal property (artwork, clothing, jewelry, cameras, sporting equipment, books and other household goods) typically does not have a formal title. Your attorney will prepare an assignment to transfer these items to your trust.

What if I buy new assets after I fund my trust?

Find out if you can take the title initially as trustee of your trust. If not, transfer the title right away. If you are not sure how to transfer it, contact your attorney for instructions.

Funding Your Revocable Living Trust

Assets you probably want in your RLT:

• Real property (home, land, other real estate)
• Bank/credit union accounts, safe deposit boxes
• Investments (CDs, stocks, mutual funds, etc.)
• Notes payable (money owed to you)
• Life insurance (or use irrevocable trust)
• Business interests, intellectual property
• Oil and gas interests, foreign assets
• Personal untitled property

Assets you may not want in your RLT:

• IRAs and other tax-deferred retirement accounts
• Incentive stock options and Section 1244 stock
• Interests in professional corporations
• Funding real estate into an RLT is state specific and may not apply in all states