What Is A Living Trust?

A living trust is a very important document used in your personal financial planning for estate planning purposes. Many people think that you need to be a wealthy person to need a trust, but this is not really true. A living trust is set up during a person's lifetime (thus the title 'living') and is designed to help you reduce estate taxes, and/or control your assets from the grave. It is its own entity. These are also called revocable trusts.

What Are The Benefits Of Having One?

1. Probate. First of all, they help you to avoid the probate process. Anything owned by this entity when you die does not have to go through probate. Probate is a public process, it can be long and drawn out, and has court costs associated with it. Avoiding it altogether is a very good thing if possible. Having this document own as many assets as possible will help you avoid those assets having to go through probate, and thus save your heirs time, money, and public scrutiny. To learn more about probate, click here.

2. Taxes Having a living trust doesn't help you avoid Federal estate taxes altogether, but having one can double the estate tax exemption amount for a family. This means that you can pass on twice as much money to your heirs before estate taxes become an issue. For example, in 2009, each person can pass on $3.5 million to their heirs free of any estate tax. This estate tax is set to be repealed in 2010, but many experts believe that it won't be. Time will tell. But for this example, let's say a married couple is worth $7 million dollars. If they jointly own everything, and the husband dies, all $7 million is now owned by the wife. There are no taxes due upon the death of the first spouse. But now when the wife dies, she can pass on $3.5 million to her heirs with no estate taxes (assuming the estate tax exemption amount is still $3.5 million) and the rest of her estate would be subject to estate taxes. Right now the top tax rate is 45%. This means the estate taxes would be $1.575 million dollars, and the heirs would get the rest.

If instead of jointly owning all of their assets, this couple used a trust, they could pass on a lot more to their heirs. With this strategy, the husbands assets would be owned by his trust, and the wife's assets would be owned by her living trust. Upon the husband's death (or wife's), his trust becomes a irrevocable trust, and the trust dictates how the money gets dispersed. It is very common for the trust to state that the money can be used for the support of the surviving spouse, and then upon her death, it gets passed on to the kids, charity, etc. This way, the money is not completely gone and gifted away. She has the ability to draw income from it for reasonable lifestyle expenses.

Now, when she dies, the husband's revocable living trust of $3.5 million gets passed on to the kids, and her trusts of $3.5 million gets passed on to the kids, all with no estate taxes due. This means the heirs got $1.575 million more because mom and dad used the trusts in their personal financial planning.

3. Control. Another benefit is it can help you control your assets from the grave. When you are drafting your document, you can specify when your heirs will get your assets and how much they will get. Maybe you have a child who is likely to blow all their inheritance 1 week after you die. It's call the, "I just won the MY PARENTS JUST DIED lottery!" Your document can specify that your child gets so much money per year for X number of years. You would name a responsible individual or corporation to manage the assets for the benefit of your heirs. This might be a family member, or maybe not. It's entirely up to you.

4. Protection. Another reason people will use this strategy in their personal financial planning is to protect their kids from someone taking advantage of them. Your trust could have separate sub-trusts created upon your death, one for each child. Instead of each child getting the money directly, their inheritance would go into a sub-trust for his or her benefit. Now the money is not owned by your child, it's owned by the trust but for the childs benefit. If the child was given the money directly, and they were married, 50% of those assets could technically belong to the new spouse. If your child later gets a divorce from that person, the ex-spouse could get 50% of those assets. Now your ex-son-in-law is driving a new corvette paid for by your hard-earned savings! How would you feel about that? If however you used the trust strategy mentioned above, those assets would be untouchable by the divorced spouse.

A slight variation of this can be used in planning for your spouse with the use of a QTIP Trust.

These are just a few examples of how a little planning can go a long way in protecting the ones you love.

You can see that being wealthy is not the only reason someone might want to use a revocable living trust in their personal financial planning. There are many scenarios where the use of this type of document could be very beneficial to your family.

What are the disadvantages of using living trusts?

Trusts can be a little expensive to set up. Depending on your situation, it may or may not be worth paying the money to an attorney to create one for you. I say paying an attorney because I believe that it's worth using an attorney to make sure you get it right. Each state may have slight differences in what you need to say, or cannot say in your trust document. Also, you want to make sure you've thought of everything and that you're going to accomplish what you wanted to. An experience attorney who specializes in estate planning will be worth his or her fee. By saving thousands or millions of dollars in taxes, and making sure that your loved ones get the money they deserve

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