A living trust can be a helpful estate planning tool, and it can help manage assets including your personal home, bank accounts, and investment accounts. But there are certain assets that you should never put in a living trust, or you could face tax implications, difficulty accessing funds you need, and other complications.
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If you’re exploring creating a living trust, then it’s important to understand how it works and which assets it’s not the right option for.
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How a Living Trust Works
Probate, which is the process of transferring your assets after you’ve died, can be time-consuming and expensive. Kelsey Simasko — attorney at Simasko Law in Mount Clements, Michigan — explained that you can use a living trust to help avoid your assets going through probate court. Living trusts may also help prevent family fighting.
“A living trust is essentially just a bucket that says, ‘I (the principal) am creating a bucket and I am in charge of everything in this bucket, and when I die, child A (the trustee) will be in charge of the bucket, and it’s their job to give $10,000 to the church and then split everything equally between my other three children (the beneficiaries),’” said Simasko.
In the above example, when the principal dies, child A will be responsible for selling the house and wrapping up the principal’s affairs, rather than those assets going through the probate process. Simasko explained that a trust offers the benefit of putting protections in place for the other beneficiaries if the trustee sells the house for less than the fair market value, or misuse the money. At the same time, the trustee doesn’t face the challenge of having to get everyone’s approval to do everything.
Cynthia Brittain — partner at Karlin & Peebles, LLP in Los Angeles — explained that a living trust also has important tax and protection benefits. “A trust document can be drafted to incorporate U.S. income and estate tax provisions that are highly beneficial,” she said. “The trust can be drafted such that the trust will shield assets from U.S. estate tax going forward.”
She noted that a trust also provides asset protection at some level on an ongoing basis, and gives the family more privacy than the probate process would.
Things To Never Put in a Living Trust
Melissa Negrin-Wiener, ESQ. — senior partner at Cona Elder Law in New York — explained that a living trust may hold almost any type of asset, including:
However, there are several assets that should not be placed in a living trust.
1. Qualified Retirement Accounts
Negrin-Wiener explained that qualified retirement accounts, such as an IRA, 401(k), or 403(b), should not be put in a living trust. Since the living trust is a separate legal entity, putting a qualified retirement account into the trust could result in tax consequences. Instead of putting a qualified retirement account into a living trust, naming a beneficiary on the retirement account will mean that account won’t have to pass through probate.
2. Health Savings Accounts (HSAs)
Negin-Wiener said that HSAs are funded with pretax money, and that money grows tax-free. If the money is withdrawn and used for medical expenses, it isn’t taxed. “Because HSAs are individual accounts, they are typically not transferred to trusts,” said Negrin-Wiener. “However, they can and should have a beneficiary named.”
3. Life Insurance
Negrin-Wiener explained that putting life insurance into a living trust isn’t always negative, but it’s important to consider the circumstances, the policy value, and the type of trust. For example, a revocable living trust can be changed or terminated during your lifetime, while an irrevocable trust can’t be changed or terminated except in very limited circumstances, so you’ll need to consider how your type of living trust will impact your control over your life insurance.
“Sometimes transfers of life insurance into an irrevocable trust make sense for Medicaid/long-term care planning purposes,” she said. “Other circumstances may call for the creation of an irrevocable life insurance trust or simply keeping the life insurance in the individual’s name and naming a beneficiary.”
4. Accounts You Need to Regularly Access
Negrin-Wiener highlighted the importance of not placing certain benefits, like accounts you need access to, into an irrevocable living trust. “Depending on the language of the trust and the purpose of the trust, the creator will not have ready access to the principal held in the trust account,” she explained. As a result, it’s important to understand your trust’s purpose and what should and should not be placed in it.
As an alternative, Negrin-Wiener suggested using a financial account. The account could be held jointly and have a named beneficiary. It could be held in trust for or be payable on death, which would allow it to quickly pass to beneficiaries so that they immediately have access to the funds after your death.
How To Set Up a Living Trust
“Living trusts are very popular and very commonly used because the probate process can be long, costly, and emotionally painful,” said Brittain. She recommends that if you’re considering creating a living trust, you take the time to interview a few estate planning attorneys to find an attorney who is the right fit for you.
“Because a trust can provide tax benefits and asset protection benefits, it’s important to seek counsel who understands concepts such as the U.S. generation-skipping tax and other more sophisticated tools used to minimize estate tax,” Brittain explained. “If you have a very small estate, or if your assets are very simple and can pass by pay-on-death accounts, such as a bank account with a beneficiary designation, you may not need a living trust.”
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This article originally appeared on GOBankingRates.com: I’m an Estate Planner: 4 Things You Should Never Put in a Living Trust
