Avoiding the costs and extensive time needed to settle an estate through probate is why people like to use trusts in estate planning. This type of trust allows you to designate a trustee to manage the assets in the trust after you have passed. This planning is critical if heirs are minor children or adults who cannot handle a large inheritance. As explained in the article titled “The Lowdown on Living Trusts” by Kiplinger, a living trust has additional benefits. However, there are some pitfalls to be cautious about, especially concerning transferring assets.
Certain assets do not belong in a living trust. Regardless of their size, you should never place some assets in a living trust, including IRAs, 401(k)s, tax-deferred annuities, health savings accounts, medical savings accounts, etc.
Placing these assets in a trust requires changing the ownership of the accounts. Don’t do it! The IRS will treat the transfer as a distribution. You will be required to pay income taxes and penalties, if any are triggered, on the entire value of the account.
You may be able to make the trust a beneficiary of the retirement accounts. However, it is not appropriate for everyone. Changes to IRA distribution rules from the SECURE Act may make this a dangerous move since the trustee may be required to empty the IRA within ten years of your death.
For practical purposes, assets like cars, boats, or motorcycles do not belong in a trust. To transfer ownership to the trust, you will need to retitle them. This transfer would result in fees and taxes. You would also have to change the insurance since the insurance company may not cover assets owned by trusts. The cost may outweigh the benefits.
Assets belonging to a trust include real estate, especially your primary residence. Placing your home in a trust will minimize the hassle of transferring the home to heirs if this is your plan. If you own property in another state, transferring the title to a living trust allows your estate to avoid probate in more than one state. Remember to get a new deed to transfer ownership to the trust. If you refinance or take a home equity line of credit, you may need to move the property out of the trust and into your name to get the loan. You will then need to transfer the property back into the trust.
Financial assets can be placed in a trust. Stocks, bonds, mutual funds, CDs, money market funds, bank savings accounts, and even safe deposit boxes can be placed in a trust. There may be a lot of paperwork, and in some cases, you may need to open a new account in the name of the trust.
Once the trust has been created, please do not neglect to fund it by transferring assets. Retitling assets requires attention to detail to ensure all desired assets have been retitled. The trust needs to be reviewed every few years, just as your estate plan needs to be reviewed. Be sure to have a secondary trustee named if you are the primary trustee.
Trusts are an excellent option if you live in a state where probate is onerous and expensive. Assets placed in the trust can be distributed with a high degree of specificity, providing great peace of mind. If you believe your oldest son will benefit from receiving a large inheritance when he is 40 and not 30, you can do so through a trust. The level of control, probate avoidance, and asset protection make the living trust a powerful estate planning tool.
Reference: Kiplinger (March 24, 2022) “The Lowdown on Living Trusts”