What is a Living Trust and How Do I Set One Up?
- Hey guys, Toby Mathis here with Anderson Business Advisors. And the question today is, what is a living trust? Do I need one, and how do I set it up? Big one. First big question is, do I need a living trust? So I'm just gonna make it like this. We all get to choose how our estate is gonna be handled. If you do nothing, you're gonna go on a default and it's gonna go to court, and they're gonna apply your state laws where you reside and where you owned real estate. And it's gonna apply and you're gonna have probates, wherever those assets may be held, and whatever the rules are for your jurisdiction are gonna control.
So there's always a plan. The default usually gets ugly because depending on the state, let's say that I had a spouse when I died, and kids, maybe kids from a previous marriage, there's all these statutes that come in and say, spouse gets half or these guys get this. There's all these different rules. Or maybe the spouse gets everything, and I just disinherited my kids from my previous marriage. All those things come in.
And so you'll absolutely have a plan, no matter what. So that's option number one, is do nothing and let the default rules kick in. It's usually costly. The ARP says, hey, it's about 20% of an estate. Smaller estates get eaten up in the probate costs, including the attorney's fees, the probate fees, the administration, the appraisals, all that fun stuff that comes along with getting to go to court.
If you don't like court, then your option is doing a living trust. And then there's something in the middle, which is the will, which gets to be probated where you still get to go to court, but you actually have a document that says, here's what I want to have done with my estate. Now, these are all upon death things that get triggered. So I always look at it and say, hey, there's kind of a continuum. There's during my lifetime, there's if I'm incapacitated, there's when I pass, and then there's post, what happens to my estate after I pass. All those things have to be addressed.
And it sounds, "Oh, no, it's not that hard." Well, hold on for a second. So during my lifetime, there's lots of things that could happen. I could be incapacitated, I could get sick while we're going through the pandemic and I might end up in a hospital, I'm not able to make decisions for myself. Who's making my medical decisions, who's making financial decisions? All that gets triggered while I'm alive. Living trust handles it all, doing nothing does not.
Like there might be some state statutes that says, "Hey, you can talk to a spouse, but there's lots of people out there that are living together that aren't husband and wife or wife and wife or husband and husband, they're not in a legally-recognizable relationship." And maybe you want that person to be able to see you if you're incapacitated, maybe you're in the hospital and you want them to be at a visit, and they're not family, under the law, then we all of a sudden have a big problem. Or maybe you are married and your hoping that your default will be that they'll let your spouse make decisions for you. I can tell you that you want it in writing and that you wanna have a HIPAA release and you wanna have your end-of-life decisions documented.
Otherwise, it doesn't matter. They're gonna have to do what they believe is in your best interest. And they'll oftentimes talk to a spouse, but if it's deemed contrary, like pull the plug or they don't want extraordinary measures, you may find yourself in a really, really bad situation if you're not documenting these things. So that's number one, is during our lifetime, if I get him incapacitated and I'm getting towards death, there's the transitional documents that are needed, like a living will that's included in a living trust, but it's actually a separate document that says, this is the individual you talk to, this is the control they have over my end-of-life decisions. Do I want extraordinary measures taken or do I not? And if I don't, then here's the individual that you can talk to to make that call. They call that pulling the plug.
Then there's one I pass, and, hey, who's getting things? Do I have things like a paid on death or do I have a joint tenancy with somebody on certain accounts that are gonna handle it? Do I have things in my name when I pass away that aren't covered like that? So let's say I own an asset in my individual name and I pass away, I may end up having to look at a will that's gonna push it into a document that covers my post-death wishes, like where do I want my things to go, do I want them distributed immediately, do I wanna have them held in trust for the benefit of somebody until they reach a certain age? If I have sizable estate, maybe I don't want a whole bunch of money going to my 12-year-old or to my grandkids when they're 10. They may not be able to handle it, or even worse, maybe it's a 21-year-old, I'm not dumping a bunch of money on them when they're making critical life decisions and maybe they choose, "Hey, you know what? Maybe I'm not gonna go to college because I have this money and I'm just gonna goof off for three years." And then they make a really bad life decisions. Maybe I'll wanna say, "Hey, that money is there until you reach 30.
It's there for health, education, maintenance, and support." You cannot do that through a will, you've gotta have some sort of trust vehicle connected to it. So living trust is our only option there or an irrevocable trust, some sort of trust. It's not gonna be handled inside of a will. The will might still be there.
And it might name the trust as the sole beneficiary of your state to make sure that there's no question, there's nobody out there making claims against your estate, and that gets transferred over. So that's upon death. And then there's post death, is your wish is carried out. And a lot of people don't realize, but you can create a legacy with a living trust just as easy as anything else. I could have, for example, life insurance on my life that goes into my trust when I pass away, and maybe I think education is super important, so I have my living trust, say my descendants get assistance with reasonable expenses of education, higher education, colleges, or universities, and this money is to be used for that purpose. And you give some instruction in your living trust, and it's there to allow people to always get an education if they want.
And it's your descendants, so it could be your kids, your kids' kids, your kids' kids' kids' kids' kids' kids' kids. We put a term of years that a lot that we can extend. You can actually go from 365 years pretty much for an infinity period of time, and the moneys, even if I don't have a ton of money, as long as I have life insurance, I can fund that thing and I'm giving it an actual indication, here's what I want. So you have really, just kind of a review, three ways. I have my pre-passing away. I know I need to have documents.
It's never gonna be covered by doing nothing or by using a will. It's always gonna require a living trust. So I need to have my power of attorneys for financial, I need to have my power of attorney for medical. I need to have my releases of medical information so a doctor can share valuable information with the people that I want making decisions for me. I need to make sure I have documented living will end-of-life decisions.
Then there's upon the passing, and if I do nothing, it's called intestate. If I die with a will, I'm going to probate that will. I'm guaranteed to go in there and I get to do the process, the probate process, which can be many years and expensive in some states statutory, like for example, in California, starts off at 8%, 4% of the lawyer, 4% of the gross value of my estate, not the net, but going to the lawyer and going to the personal representative. And it adjusts the bigger the estate is. And then there's the living trust, which requires no probate. It just requires administration by somebody that I trust or a company or a fiduciary to handle it to make sure that whatever my wishes are, that they're carried out.
Of the three, doing nothing, will or living trust, I'm always gonna side with the living trust, and so the answer to the question, do I need a living trust, is always gonna be yes, if you're asking me. Because I do not look and say, "You're estate's too small," because I think that's just not wise, not nowadays. It's almost always gonna be less expensive to do the trust and to not have the probate versus doing the probate if I do just a simple will and it never answers those pre-death questions. I cannot do that with a will. I cannot cover the financial matters or health matters with a will, I have to have those financial power of attorney.
I have to have that living will. I have to have a HIPAA or whatever your state may call it, by the way. Some states call it a power of attorney, some call it a directive, like there might be a healthcare directive versus a healthcare power of attorney. It's nomenclature. It's I have financial, somebody designated to handle my things, medical, I have somebody to cover my things, end-of-life decision, I have something that the hospital, the doctors can talk to.
When I pass, I have, here's where it gets accumulated. Is it going into the trust or is it being distributed out to be a will. I prefer to have the trust so I can go on for a longer period of time. If it goes into the trust, what are the terms of the distributions? Is it restricted on age, the other restrictions for alcohol or drug abuse or things like that? Or is it just going in maybe, we call it HEMS, health, education, maintenance, and support. There's these very bright line, like, hey, if I just want it to be held there in case my future generation, maybe my kids need it, maybe my grandkids, maybe my great, great grandkids, maybe there's money there if they need it. So for health, education, maintenance, or support, hey, they're never gonna be homeless, they're never gonna be without, but they can't take my money and buy a Lamborghini.
But if you need a vehicle, there's enough money there to cover the cost of appropriate vehicle. And you're not gonna see big abuses, you're not gonna be see big lifestyle changes. It's there as a safety net in case somebody gets sick or they need to go to school, or they have those types of things. That's called HEMS, and that's fairly common. Hey, it's going into trust for this purpose, but you don't get to go in there and just take a million bucks at your willy nilly and blow it on a trip to Vegas and making bad decisions. It's also really good because if you're worried about your kids love life and their decision-making, you don't have to worry about divorces because the money's not in their pocket and available to spouses.
If I just distribute money, then it's theirs, and then if they get divorced, it can get wrapped up in there. Even though it's technically considered separate property, it always gets brought in. And it's always a factor that the court can consider when they're dividing up assets because it's an equitable division. So they always look and say, "All right, what does everybody have?" It's not just bright line. The court gets to consider all available resources.
If it's sitting in a trust and they don't have that immediately accessible, it's not their asset, it's not divvied up in property distributions. It may be considered if they're saying, "Hey, this person really needs this support." You may say, "Hey, they're a beneficiary of a trust," but you're looking at the trust and you have a trustee that says, "Hey, it's not a guarantee." So it's not like the money is sitting in their account.
So if you're going to give your children a whole bunch of cash, and they're married, always understand that that ends up being blended into those assets of the marriage. At some point, it's gonna be ignored where it came from unless they could trace it, unless they kept it completely separate, which nobody ever seems to. And here it is that years later, somebody goes through a divorce and sometimes those assets get divvied up and you didn't even intend it, oops. Or if you're not careful, you could disinherit children. So if I have nothing and I'm just leaving it to a spouse, maybe I had a previous marriage.
And I'll just give you an example. Somebody grows up, they have kids, spouse predeceases them, they get remarried. They're not thinking anything of it. 70, 80 years old, and you pass, and you don't even realize that you just gave your entire estate to the new spouse. It's the Anna Nicole Smith syndrome where Nicole Smith was a playboy model, 28, married a guy who's 80 years old in a wheelchair.
And he predeceased her and she said, "It's mine," and all of his kids were disinherited. They were able to prove fraud, but it went on for years, and it became a big, big issue when all he had to do is to be a living trustee with his previous spouse, especially as it would have gone. And at most, there's half of the estate that would have been at risk, but it would have prevented the kids from being disinherited outright. Now, that was a egregious situations, rarely like that.
Usually what happens is somebody just gets remarried and doesn't think anything of it and leaves everything to their spouse, not realizing that this actually happened to my family. So I could tell you firsthand knowledge that it does happen is it ends up going to somebody and that somebody in their family, when they're deceased, it goes to their kids and not your kids. So you get remarried and you leave your everything to your spouse. You probably just disinherited the kids from your biological children from the previous marriage and gave it to somebody else's kids. So that's probably not something you're intending to do.
So we make sure that there's a living trust that says, "Hey, this amount comes over here for the benefit of my surviving spouse. And they have it until the end of their life, and then it goes to my biological children." So that's usually how you do it, it requires a living trust. So there's the do nothing, there's the will, and there's the living trust.
Obviously, the biggest value and the one that's most appropriate and handles all the issues is living trust, which is why I always recommend them. They're much less expensive than having disputes. They're much less expensive than the pain and sorrow of not having designated individuals.
And I'm always doing this weighing test. And no matter what, you have a body, you're having insureability, and you can create an estate plan in legacy with the living trust, you can't do otherwise. So it becomes my only tool. We have to use a trust, whether it be revocable, irrevocable, or sometimes we can use charities and foundations. Sometimes we're using other entities to create legacies.
All of them necessitate the use of living trust that covers the individual that we're working with. And so I can say with certainty that barring extreme circumstances that I've yet to really see the living trust is almost always gonna win out. Now, how do I put one together? It's as easy as documenting your intent in a contract. That's all living trust is, is a contract with you as a grantor, with you as a trustee saying, "I'm gonna watch over my own stuff," or me as a beneficiary. And then when an event occurs, so for example, just think of a triangle, I'm the one who gave it, I'm the one who watches over it, I'm the one who benefits.
If I can no longer take care of it, then I'm bringing in a new trustee. So I might designate a trustee, maybe it's a spouse, surviving spouse, maybe it's a company. If I don't have a spouse, maybe it's a child that you really trust or somebody else that you trust, family member that you trust. And they're handling the asset for my benefit during my lifetime.
I will not be the grantor in this situation. I'm the one who gave the asset into the trust. So when I pass away, no more grantors, when I pass away, we just change the trustee.
And then I'm changing the beneficiary. It's for my benefit during my lifetime, but if I leave this earth, the new beneficiary would be, for example, my descendant or my kids. Or maybe I'm breaking it into two trusts, one for surviving spouse and one for children, those types of things. Whatever I can conceive can be drafted, and it's just a contract saying those things.
Once you understand that, then you just realize, wait a second, I just need to get these contracts drafted up. The living trust is easy. And then I say, "Hey, what if somethings... I have to make sure I fund it."
What if I forget, then we have a catch-all. That's called a pour-over will. That says anything that's left in my name, that's in my name, I name my living trust as the sole beneficiary of my state. You make sure you have your health care documents, your power of attorneys or healthcare directives done to say, "If I can't make decisions for myself, here's who I designate, if I'm not able to make financial decisions for myself, here's who I designate." If I am in extreme circumstances where I'm not gonna be recovering, is it okay to terminate life early by pulling the plug or discontinue extraordinary measures. If the benefit's not gonna be there, it's a significant burden, that's called a living will.
That's all in the living trust document. And it's just documenting those things, signing and putting in place. Once you do that, the big question is, can I change it? Yes, during your life, you can change anything so long as you're capable of making those decisions.
Generally speaking, I don't give a power of attorney that let somebody else change my estate because they might change it to something I'm not in agreement with. So as soon as I'm incapacitated, my trust is sitting there pretty much locked in. If I pass away, it becomes irrevocable, and now nobody can change it, they're just gonna exercise what I intended. There's something called decanting, I won't get into all that, but your intent can be carried out in the future by that trustee for the benefit of your beneficiaries. The trustee does not need to be a beneficiary.
In fact, it's better if they're not. The trustee could be a fiduciary, it could be an attorney, it could be a trust department of a bank, it could be a trust department, just a trust company. There's plenty of options.
Your beneficiaries, even if they're not the trustee can say, "Hey, we don't like these trustees," and get together and remove them, if you want. So let's say you had a company, the trust department of your bank, and that was the trustee of your trust for the benefit of this class of people, your beneficiaries, or future descendants or whatever. And the descendants were really having a difficult time with that particular trust department. Those beneficiaries could all get together and say, "Hey, you know what? They're not acting in our best interest. Maybe they're doing something shady.
We're gonna change it and we're gonna elect a different trust company and move it over here because we're more comfortable with them." That's fine. The trust companies are still held to a fiduciary standard, and they're gonna do what the written documents say. So it's a great one.
If you make your kids, for example, the trustees, and they're also the beneficiaries and there's any restrictions to distributions, expect them to be ignored because they're gonna say, "Hey, I'm the beneficiary, I'm not gonna object. So let's just distribute all the money." So if you're gonna put conditions on it, like it's for education, for travel, it's for health issues, whatever. Or, hey, you can't be on drugs, you have to be in your right mind, all those things. If you're gonna put any restrictions in it, make sure that they're not the trustee, because again, they could just ignore your written instructions.
You want it to be a third party who's gonna follow your instructions, trusted advisor, or again, trust departments of banks. Really good. There are trustee, professional trustees, or maybe it's your brother or sister or somebody, and then it reverts.
And it becomes a professional fiduciary. And you can just leave it as a class. Hey, the beneficiaries get to pick the trustee so long as they're a fiduciary, attorney and accountant, or a licensed trust company. Because they're always gonna follow what the law says, they're not just gonna be influenced by a beneficiary because they have licensing that they have to worry about. If you do create a set scenario where you have somebody that is gonna be the trustee, so let's say you do say a sibling or you ask a trusted advisor and you're worried about overburdening them, don't worry. A well-written living trust will always allow them to hire that out and hire a professional to help them or to do the activity at their stead.
And they get to pick it. So they step into your shoes. And if you didn't wanna manage your money, you could hire someone to do it.
So if they don't wanna manage it or handle it, they can hire that out as well. That's always an option. So even though it seems like there's a responsibility there and you might be overburdening them, don't worry, they can get help if they need it.
Or then they could always resign. They say, "You know what? I'm tapping out," and then they go to the trust document, which again, usually gonna be an attorney and accountant or a professional fiduciary company. They need to say, "Hey, we need a trustee." Sometimes they'll charge a point or something like that.
They'll charge a percentage, a hundred basis points on it, saying, "Hey, I'll manage everything. Do the tax filings and watch over all the money and make sure it's diversified." There's lots of rules that they have to follow for the benefit of your beneficiaries. Or maybe you're somebody who says, "Hey, you know what? I just want my kids to be 40 years older or more before they get to the complete distribution."
You could do 25% at 25, 25% at 30, 25% at 35, then whatever's left at 40. You could do all of that inside of a trust. Whatever you could conceive of and whatever restrictions you wanna put on there, we could put in that document.
So the living trust becomes really, really cool. The biggest thing that we see goofed up on a trust is you put the trust in place, you sign it, you notarize it, it's there, and then you don't transfer assets into it, you keep your bank account in your name, you keep your house in your name. It's not fatal because the portal will capture it and put it in there.
But it's so much easier if you actually fund the document during your lifetime. We do put in there like a schedule of gifts that you could change it whenever you want. Get a good draft. A well-drafted living trust is gonna have some flexibility built in. And one of those things might be, hey, if I wanna leave my good China tees to child number one, and I wanna leave my wedding ring to child number two, and I wanna leave the furniture to child number three, and I wanna leave a bunch of my art to child number four, and maybe I wanna give my fishing rods to my neighbor. You can do all of that in a schedule of gifts and you don't have to go back to your lawyers every time you do it.
You could just write it in and initial it as long as your trustee can figure out what the heck you're trying to do, they'll follow it, like, "Oh yeah." Unless say you give it away twice, it's gonna be the later, it's gonna be the later. I should say the latest date.
Again, a lot of it is common sense, and you don't require a court to look over your shoulder. If you don't do the written document, expect a court to be looking over your shoulder, whether it's dying intestate or with a will. The court is the one who's distributing the asset and signing it off. And so you're gonna have a complexity, you're gonna require... In many cases, it's gonna end up being a year or two process and a lot more complexity and expense associated with it to go through the court route, which again, we prefer to avoid.
We always feel like people's affairs should be private. I don't think you need it in a courtroom, I don't think you need all your assets spelled out there for the public to see or for anybody to pull up and look at whatever it is at your state. You do it with a living trust and you have the privacy, you don't have to worry about it. I always tell people, it's the difference between looking at Michael Jackson's estate and Frank Sinatra's. One is all out there in the public and anybody can see all the nonsense that was going on, and the other one's a completely private affair, the courts don't get involved, the public doesn't get to see, it's handled privately. And I prefer to be Frank Sinatra.
I prefer my estate and my client's estates to be private. So that's about it for living trust. Do you need one? Absolutely, you need a lot more. Living trust is a very comprehensive document, includes a whole bunch of different stuff, everything from healthcare, to your HIPAA releases, your financial documents, your end-of-life decisions, your pour-over will, your schedule of gifts, and then your distribution instructions. It includes all that. So do you need one? Yes.
Is it the only game in town? Pretty much. There's some other things you could do, but everybody needs advocates for their health and for their finances. Everybody needs end-of-life decision makers that are in writing so that they can communicate with your providers, your healthcare providers.
Everybody needs to have their legacy documented of whatever it is that you want in writing. Don't leave it to chance and don't let it default to some state's statute that you weren't involved in or may not even know what it says. And everybody has the ability to create a legacy just because we have a life. If I did nothing more than bought a bunch of insurance on myself and named my living trust as the beneficiary, that's good too. Everybody thinks, "Well, I don't have enough money for that." Yeah, you do, everybody does.
Because everybody's life is worth it, and you have the ability to insure. You could even insure insurable interests of third parties and still have the trust named. If you're not able to do it on your own life, a spouse second to die policy, things like, that would work. And you can absolutely create these things in a matter of sometimes weeks, sometimes days if necessary, but no matter what, within the year, you could create a very good comprehensive estate plan. It is not tens of thousands of dollars, it's significantly less, and it's gonna be cheaper than the alternative and emotional and dollar-wise cost. So again, do a living trust, implement it, fund it, pay attention to it.
You can always change it. You don't have to redo it, you can just change a little tweaks this, amend a paragraph here or there. You're allowed to do that. It's yours, and it's completely at your discretion until such time as you're no longer there to continue to make changes to it. In which times it becomes irrevocable.
And now you've left a legacy in writing that somebody couldn't follow and make sure it's implemented. So I hope that helps you make a decision. Hope you get your living trust pretty quick.