Estate planning often sounds more complicated than it really is. Where estate planning, for many, begins and ends with a will, you may have also heard the words “living trust” being thrown around. If that isn’t complicated enough, there are also revocable and irrevocable versions of a living trust, and you may find yourself wondering if this is something you really need in the first place.
But that really begs the question of what actually is a living trust? How do you set up a living trust in California, and is it a good idea to do so? It may sound complicated, but as with many things, demystifying something starts with a good grounding on the basics.
What is a living trust?
A living trust, also called an inter vivos trust, is a legal arrangement whereby a trust is created to hold and manage assets during a person’s lifetime. This is in contrast to a will which only takes effect upon a person’s death.
A living trust as a legal arrangement involves three specific roles:
- The Settlor: also called the Trustor or Guarantor, this is the person who creates the trust. The Settlor also funds the trust by the transfer of their properties or assets into the trust.
- The Trustee: the person tasked with managing the trust. This is a fiduciary role, whereby the trustee can hold legal title to the trust property in their capacity as trustee. Typically, the settlor serves as their own initial trustee, with a successor trustee tasked to take over later on.
- The Beneficiary: these are the individuals or entities for whose benefit the trust is created. The beneficiaries may receive income generated by the trust assets, the assets themselves, or both.
One of the reasons that a living trust is popular as an estate planning tool in California is because it helps families avoid probate. Trust properties are not considered part of probate assets, and depending on the terms of the trust, the properties can pass directly to the beneficiaries without going through court-supervised probate proceedings.
Another advantage to a living trust is the continuity it provides the settlor in managing the trust properties should they become incapacitated later on. A successor trustee is typically nominated in the terms of the trust, and the successor trustee takes over management of the trust assets, should the settlor later becomes unable to do so, and without requiring additional authorization or further court involvement.
The Two Types of Living Trusts
Broadly, there are two types of living trusts: revocable and irrevocable.
Revocable Living Trusts
As its name suggests, revocable living trusts can be changed whenever the settlor desires to make alterations to the trust terms.
For instance, if the settlor wants to add or remove assets, change the beneficiaries, change the trustees or successor trustees, amend the terms of the trust, or simply revoke the trust entirely, they are free to do so.
This makes the trust arrangement quite flexible and allows a person to design a trust that fits their changing needs. Family members may be added or loved ones may pass away; new properties may be acquired or the settlor may want to sell of some old properties; or the choice of trustee may also change over time.
California law strongly favors revocable trusts. The presumption under Probate Code §15400 is that unless the trust instrument expressly declares it to be irrevocable, the presumption is that the trust is revocable.
Irrevocable Living Trust
An irrevocable living trust, on the other hand, is as its name implies: irrevocable.
Once an irrevocable living trust is created and funded, the settlor cannot freely change it or revoke it. The practical effect is that the settlor effectively relinquishes ownership and control over their property once transferred to the trust.
One might wonder why anybody would create an irrevocable living trust? Surely it is preferable to retain the option to make changes to a trust later on.
Irrevocable living trusts are often used for more advanced estate planning purposes – those designed to avail of certain legal benefits such as asset protection and tax benefits.
Assets belonging to an irrevocable living trust may be shielded from creditor claims, which makes it useful as a long-term wealth preservation strategy, or even to help preserve the assets for individuals in high-liability risk professions. Though it must be noted that California does have strict rules against using trusts to defraud creditors.
In addition, if assets are transferred to an irrevocable living trust, they are no longer considered part of a person’s gross estate, which may help to reduce federal estate taxes since the settlor has relinquished ownership and control over the assets. This is in contrast to revocable living trusts, where the trust properties are still treated as the settlor’s properties for tax purposes because the settlor retains the power to amend or revoke the trust.
Which One Is Right for You?
Ultimately, the choice of whether you should set up a revocable or an irrevocable living trust depends on the objectives of the trust. If you are aiming to avoid probate and at the same time have a plan should you ever become incapacitated, a revocable living trust will allow you to do this and retain control over the trust at the same time.
On the other hand, irrevocable living trusts are intended to address more specialized goals including long-term wealth preservation or specialized tax planning.
Ultimately, it comes down to how much control you wish to retain over the trust, or whether your goal is to avail of the additional protections offered by irrevocable living trusts.
If you are considering setting up a living trust and would like to discuss your options, give us a call and we will help you with your estate planning needs.