A living trust can be a helpful estate planning tool, helping to manage assets such as your personal home, bank accounts, and investment accounts. However, there are certain assets you should never put into a living trust because doing so can result in tax consequences, difficulty accessing needed funds, and other complications.
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If you are considering setting up a living trust, it is important to understand how it works and which assets it is not the right option for.
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How a Living Trust works
Probate, or transferring your assets after you die, can be time-consuming and expensive. Kelsey Simasko, an attorney at Simasko Law in Mount Clements, Michigan, explained that a living trust can help you avoid having your assets go through probate court. Living trusts can also help prevent family disputes.
“A living trust is basically just a bucket that says, ‘I (the principal) create a bucket and I am responsible for everything in that bucket, and when I die, Child A (the trustee) will be responsible for the bucket and it is his job to give $10,000 to the church and then divide it all equally among my other three children (the beneficiaries),'” Simasko said.
In the example above, Child A is responsible for selling the house and winding up the principal’s affairs after the principal’s death, rather than those assets going through the probate process. Simasko explained that a trust offers the benefit of providing protection to the other beneficiaries if the trustee sells the house below market value or misuses the money. At the same time, the trustee doesn’t face the challenge of having to get everyone’s consent for everything.
Cynthia Brittain — a partner at Karlin & Peebles, LLP in Los Angeles — explained that a living trust also offers important tax and protection benefits. “A trust document can be designed to include U.S. income and estate tax provisions that are extremely beneficial,” she said. “The trust can be designed to protect assets from U.S. estate tax in the future.”
She pointed out that a trust also provides a certain degree of permanent asset protection and gives the family more privacy than would be the case with an estate plan.
Things you should never put into a living trust
Melissa Negrin-Wiener, ESQ. – senior partner at Cona Elder Law in New York – explained that a living trust can hold almost any type of asset, including:
However, there are several assets that should not be placed in a living trust.
1. Qualified retirement accounts
Negrin-Wiener explained that qualified retirement accounts such as an IRA, 401(k) or 403(b) should not be put into a living trust. Because the living trust is a separate legal entity, putting a qualified retirement account into the trust could have tax consequences. Instead of putting a qualified retirement account into a living trust, naming a beneficiary on the retirement account means the account does not have to go through probate.
2. Health Savings Accounts (HSAs)
Negin-Wiener said HSAs are funded with tax-free money, and that money grows tax-free. When the money is withdrawn and used for medical expenses, it is not taxed. “Because HSAs are individual accounts, they are not typically transferred to trusts,” Negrin-Wiener said. “However, you can and should name a beneficiary.”
3. Life insurance
Negrin-Wiener explained that putting life insurance in a living trust isn’t always a negative, but it’s important to consider the circumstances, policy value and type of trust. For example, a revocable living trust can be modified or terminated during your lifetime, while an irrevocable trust can only be modified or terminated under very limited circumstances, so you need to consider how your type of living trust will affect your control over your life insurance.
“Sometimes transferring a life insurance policy into an irrevocable trust makes sense to plan for Medicaid or long-term care benefits,” she said. “Other circumstances may require setting up an irrevocable life insurance trust or simply continuing the life insurance policy in the person’s name and naming a beneficiary.”
4. Accounts you need to access regularly
Negrin-Wiener stressed the importance of not putting certain assets, such as accounts you need access to, into an irrevocable trust. “Depending on the wording and purpose of the trust, the creator may not have direct access to the capital held in the trust account,” she explained, so it’s important to understand the purpose of your trust and what you should and shouldn’t put in it.
As an alternative, Negrin-Wiener suggested using a bank account. The account could be jointly held and have a named beneficiary. It could be held in trust or be payable on death, which would allow for quick transfer to beneficiaries so they have immediate access to the funds after your death.
How to set up a living trust
“Living trusts are very popular and used very frequently because the probate process can be lengthy, costly and emotionally painful,” Brittain said. She recommends that if you are considering setting up a living trust, you take the time to interview a few estate planning attorneys to find an attorney who is a good fit for you.
“Because a trust can provide tax and asset protection benefits, it’s important to seek out an advisor who is familiar with concepts such as the U.S. generation-skipping tax and other more sophisticated tools for minimizing estate taxes,” Brittain explained. “If you have a very small estate, or if your assets are very simple and can be passed through pay-on-death accounts, such as a bank account with a beneficiary designation, you may not need a living trust.”
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This article originally appeared on GOBankingRates.com: I’m an Estate Planner: 4 Things You Should Never Put in a Living Trust
