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Living Trust

What is a living trust?

A living trust is a trust you create while you are still alive. You can serve as the trustee to keep control of the assets placed in the trust. But you should also name someone to succeed you when you die or if you become incapacitated. The primary goal of a living trust, sometimes called an inter vivos trust, is to transfer property outside the probate process while retaining control over it. With careful planning, creating certain types of trusts can also provide important tax advantages for you and your heirs.

What is a revocable living trust?

A revocable living trust is a trust that you create while keeping the right to modify it at any time. For example, you could replace the trustee, change the beneficiaries, or dissolve the trust completely whenever you so desired. With a revocable living trust, you are allowed to transfer as much property as you want to the trust without owing any gift tax. When you die, the property can bypass the probate process and instead can go directly to the person or people you have chosen to receive it. A revocable living trust, however, is not a tax shelter. It won't reduce the income tax you owe while you're still alive and it won't reduce the inheritance taxes that may be due when you die. If you want a trust that provides such benefits, you should consider forming an irrevocable living trust or another type of trust.

What are the primary differences between a revocable living trust and an irrevocable living trust?

A living trust is a written agreement established while you are alive. You typically name yourself as the trustee of your trust, and another person-typically a relative, friend, lawyer or bank trust department-as a successor trustee to distribute the trust's assets if you die, or to act on your behalf if you become incapacitated. A revocable trust means the person who establishes it can change the terms of the trust at a later date if desired. An irrevocable trust, once established, cannot be changed. Setting up an 'irrevocable' trust has tax advantages but they are rarely used since most people don't like to set up something they can't change later.

Do living trusts lock up your assets?

You may or may not be able to get back the assets you place into a living trust. It primarily depends on whether you choose a revocable living trust or an irrevocable trust. If you choose a revocable living trust, you are free to modify the trust or even dissolve it whenever you wish. This includes the power to place your assets into the trust and remove them later. If you instead choose an irrevocable living trust, the assets you place in the trust cannot be moved until you die. Irrevocable trusts can provide some important tax benefits that revocable trusts do not, but you have to give up some flexibility in order to obtain them.

Will my beneficiaries have to pay estate taxes or go through probate if I set up a living trust?

A revocable living trust allows you to "self-probate" your assets while you are alive and competent. The funding or re-titling component of the revocable living trust process allows you, as the trust maker, to transfer your assets into your trust and consequently avoid the probate process. Whether forming a trust will reduce your estate taxes will largely depend on the type of living trust that you choose to create. If you form a revocable living trust, you can move assets in and out of the trust anytime you wish, but you will not reduce your taxes. If you choose an irrevocable trust, the assets you put in the trust will have to stay there, but the trust may provide you with tax advantages.

Should I name my revocable living trust as beneficiary of my IRA?

If you have created a revocable living trust, you can name the trust as the beneficiary of your Individual Retirement Account. However, it may make more sense to use the trust only as a secondary, or "back-up," beneficiary-especially if you are married. According to "The Truth About Money" (Georgetown University Press, Washington, D.C.), "In many cases, it is preferable to name a spouse or some other designated beneficiary as the primary beneficiary of your IRA. You can then name your revocable living trust as the contingent, or secondary, beneficiary. By using this succession of beneficiaries for your IRA, your spouse will have the spousal elections that are available upon the death of the IRA owner. If the owner and spousal beneficiary are killed in a common accident, then the revocable living trust can serve as a receptacle for the IRA proceeds." In other words, naming your spouse or other beneficiary as heir to your IRA can provide the beneficiary with more flexibility in choosing how the account's assets will be used after you're are gone.

When should I set up a trust? Do I need one at all?

It depends on the size of your estate and the purpose of the trust. For example, if you mainly want a living trust to protect assets from taxes and probate but your estate is under the current federal tax floor ($650,000 for 1999) and small enough to qualify for quick and inexpensive probate in your state, some lawyers would tell you it isn't worth the cost. However, a trust can do a number of things a will can't do as well unless the will establishes a trust or pours over into a trust. If you want to avoid a court hearing if you become incompetent or unable to provide for yourself, or if you want to provide for grandchildren, minor children, or relatives with a disability that makes it difficult for them to manage money, a trust has many advantages. If you have a trust, your trustee can manage assets efficiently if you should die and your beneficiaries are minor children or others not up to the responsibility of handling the estate. And a trust can protect your privacy; unlike a will, a trust is confidential.

How do I decide which type of trust to use?

Two basic kinds of trust exist: revocable and irrevocable. Revocable trusts can be changed or even canceled any time after they are established. For this reason, they do not remove assets from a grantor's estate; the government considers those assets as being under the grantor's control. With a revocable trust, you must pay income taxes on revenue generated by the trust and those assets remaining at your death may be subject to estate taxes. Be absolutely sure of your decision before going ahead with an irrevocable trust. Irrevocable trusts cannot be altered or canceled once they are established. The assets placed into an irrevocable trust are permanently removed from your estate and transferred to the trust. The trust becomes a separate taxable entity that pays taxes on the income and capital gains it generates. Therefore, when you die, the appreciation of those assets is not considered part of your estate and thus avoids estate taxes.

What is an irrevocable trust what are its tax advantages?

When you create a trust, you decide whether the trust will be revocable or irrevocable. A revocable trust can be changed or even dissolved by you at any time. An irrevocable trust, however, can never be changed. The assets you put into it must stay there. Beneficiaries cannot be added or deleted. And the only way to change the trustee is for that person to die or agree to resign. Why, then, choose to make your trust irrevocable? For tax advantages. An irrevocable trust itself pays income taxes on what its assets earn. When you die, the trust property is not part of your estate and will not be subject to death taxes. Conversely, revocable trusts offer no tax benefits at all. If you want lots of flexibility, make your trust revocable. But if you want tax breaks, you must forgo flexibility and form an irrevocable trust instead.

What are by-pass trusts?

A by-pass trust is a trust that is created by your will when you die. If you create a by-pass trust, you can structure it so that someone -- usually your spouse -- benefits from the trust during his or her lifetime while the principal is held in trust for your children or other beneficiaries. Under this type of arrangement, your spouse or other designee would get the income generated by the assets you placed inside the trust. Your spouse could draw up to 5% of the trust's assets or $5,000 a year, whichever is greater. If your spouse doesn't need the money, it could simply stay in the trust and continue to grow. And even if the value of the trust mushroomed by the time your spouse dies, no federal estate tax would be due because the value of the trust -- for tax purposes, at least -- would have been set at the time of your death.

What is a dynasty trust?

A dynasty trust is an irrevocable trust that allows rich people to avoid paying multiple estate taxes on property they want to pass to different generations of their descendants. For example, a grandmother could establish a dynasty trust for her son and her son's descendants. The trust could be created while grandmother was still alive, or upon her death.

What are family trusts?

A family trust is a trust that has been established for the purpose of passing assets to children or other heirs rather than to a surviving spouse. A lifetime, or inter vivos, family trust is a common technique used to avoid probate. A trust holds assets so that when you die, those assets will not be considered part of your estate for probate and possible estate tax purposes. A trust agreement permits you to set aside assets for the ultimate benefit of another person, called the beneficiary. In some cases, the beneficiary will receive income from the trust assets for life, while in other cases, he or she will receive principal from the trust. A family trust can be revocable or irrevocable. You may change or cancel a revocable trust whenever you wish. On the other hand, be very certain before you set up an irrevocable trust. Once established, it cannot be altered or canceled.

What is a marital trust?

Under current tax codes, you can transfer all of your estate to your surviving spouse without having to pay federal estate taxes by using the unlimited marital deduction. According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver), "To take advantage of the unlimited marital deduction, you can provide in a will or trust that, upon your death, all your assets are to be distributed outright and free of trust to your spouse, or you can provide that all your assets will be transferred into a trust for your spouse's benefit during his or her lifetime. This type of trust is commonly referred to as a "marital trust." An outright distribution to your spouse or a distribution in a marital trust for the benefit of your spouse will defer the assessment of a federal estate tax against your assets until the subsequent death of your spouse." It's also worth noting that marital trusts are extremely flexible, allowing you and your spouse plenty of leeway to mold it however you wish. If you're married, forming a marital trust now can provide you or your spouse with some important tax breaks when one of you dies.

What is a qualified minor's trust?

A qualified minor's trust is an irrevocable trust you establish for the benefit of a minor. Because it is irrevocable, it cannot be altered or canceled once established. Assets placed into an irrevocable minor's trust are permanently removed from your estate and transferred to the trust. The trust becomes a separate taxable entity that pays taxes on the income and capital gains it generates. Therefore, when you die, the appreciation of those assets is not considered part of your estate and thus avoids estate taxes. Trusts are useful if you want your assets held separately for your young children. Upon your death, the trustee must report expenditures annually to a judge. If the trustee and the guardian of your children differ, this requirement acts as a check against the guardian's running off with your children's inheritance.

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