A living trust is created during a person's lifetime and comes in two types: revocable and irrevocable. A revocable trust allows you to freely transfer your property in and out of the trust. By contrast, the maker of an irrevocable trust cannot serve as trustee or exercise control over the trust's assets, so irrevocable trusts are less flexible than revocable trusts. Many people fund their revocable trusts with their most valuable assets, which usually include the family home, bank accounts and investments.
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One of the most common reasons people create trusts is the desire to avoid probate, which can be a lengthy and expensive process. But it's not always necessary to place assets in a trust to avoid probate because certain types of property pass directly to a decedent's heirs automatically upon his death. Common nonprobate assets include those with named beneficiaries and jointly-titled real estate with rights of survivorship. Assuming your estate consists mostly of nonprobate property and you don't need a trust for other reasons, like protecting assets from creditors, a living trust might not be worth the time and expense.
Life Insurance Trusts
If you've accumulated considerable wealth, you might be concerned about your loved ones owing estate taxes. An irrevocable life insurance trust is an estate planning tool for reducing or even eliminating estate taxes. The trust is funded with a life insurance policy that names the trust as the beneficiary. Because the trust, and not you, owns the policy, it isn't counted as part of your estate when you die. A very large policy can significantly reduce the size of your taxable estate.
Generally speaking, placing some types of assets in a living trust can be problematic. Retirement accounts like 401(k)s, for example, must be owned by an individual to qualify for deferred income tax treatment. If you change the title to a living trust, the transfer is treated as a withdrawal of the entire account balance, which triggers tax on the total amount. An alternative is to name the trust as a primary or secondary beneficiary of the 401(k).
Spendthrift trusts are popular with parents and grandparents who want to provide for their offspring but wish to safeguard against the children's future irresponsibility. With this type of living trust, the beneficiary is entitled to benefit from the trust's assets, but has no authority to transfer or sell her interests. The trustee maintains complete control over the trust, so it is protected from the beneficiary's creditors until she receives funds from the trust's assets.