What Is a Living Trust and Why Have One?

A living trust is a trust, a distinct entity from the settlor (the person who formed it), yet at the same time, it is fully revocable and amendable by the settlor. The settlor can also name themselves or whomever they want as Trustee of the trust and keep complete control over the trust. Below are the three reasons why you need a living trust.

Avoiding Probate with a Living Trust

First, to avoid probate. Because probate is so long, expensive, and horrible, most people do not want their spouses or other heirs to have to go through it after their death. Thus they create living trusts. Because a trust is a distinct entity, and not the same as the settlor, when the settlor dies, the trust continues to hold all property. It may be the case that the trust says that at the time of the settlor’s death all assets are to be paid out, it may not be, but either way, the trustee will be able to take such actions without court intervention. It will make for a much easier, more seamless process.

Living Trusts and Tax Planning

Second, you will be able to do tax planning. Federally, every American has a $5,000,000 lifetime exclusion for all gifts made during life and upon death, indexed for the effects of inflation from 2011 ($5,490,000 in 2017). This may seem like a lot of money, but Massachusetts only has a $1,000,000 exclusion, and once you exceed it, it retroactively affects all assets in your estate. With a trust we can work around this.

Imagine for a moment that you and your spouse have about $2M together. You may think great, we have $2M plus we each have a $1M exclusion, we will be all set. Except unlike on a federal level, there is no portability. This means that if you die leaving all assets to your spouse, your spouse now has a $2M estate and is not entitled to use your $1M exclusion. Thus your spouse will have a taxable estate.

By using a trust we can instead create what we call an AB trust. It will be one trust that after the first spouse's death becomes two. The first trust will be the survivor's trust to hold the surviving settlor's assets. They can do whatever they want with it. The second trust will be the bypass trust and will be funded with the deceased settlor's assets.

The surviving spouse can be the trustee of the Bypass Trust, can receive all net income annually from the Bypass Trust, can pay themselves principal for their heath, education, maintenance, and support, and can withdraw 5% of the principal each year for any reason. However, the taxing authorities will still not consider it the property of the surviving spouse and so it will qualify to use the exclusion of the deceased spouse. This way we use the full $2M of exclusion.

Joint Tenancy and Living Trusts

Third, you avoid the problems of using joint tenancy, i.e. that you give up part ownership in the property (with a trust you are the full owner) and your heirs will get a complete step-up in basis. You also avoid the pitfalls of just using life insurance in that you are not paying costly mortality costs and all of your assets will be included.

The only drawback to using a living trust is the cost to set one up. However, the cost is much cheaper when compared to the costs of probate.