Legacy Assurance Plan: Understanding the Do’s and Don’ts of Trust Funding

Summary: A living trust can be an extremely beneficial part of an overall estate plan. A living trust can help accomplish many goals, such as avoiding probate. To get the most from your plan, though, you’ll need to make sure that you’ve properly funded the assets that should go into your trust and avoided doing so with those that should not go into a trust. Regardless of the makeup of your assets, it is important to understand that a living trust can offer many advantages beyond just probate avoidance, including planning for mental incapacity and reducing the risk of a successful estate plan legal challenge.

If you looked into, and learned much about, revocable living trusts, then you probably know a few key basic facts about them. One of the things with which you’re probably familiar, then, is the necessity of trust “funding.” Funding a trust refers to the process of transferring legal ownership of your assets from you as an individual to you as the trustee of your living trust. Your living trust can only control those things that are properly funded into it. A living trust with no assets in it is like a car with no fuel in the gas tank. No matter how well designed it is, it won’t be capable of doing anything if it’s empty.

So, with that in mind, you’ve probably heard of the importance of “fully funding” your trust. Does full funding mean that you should transfer everything into your living trust? Actually, no. There are certain types of assets that you should take great care to avoid funding into your living trust. Funding these assets could cause you to suffer many types of negative consequences, especially when it comes to taxes.

For example, you definitely should not fund any type of qualified retirement account into your plan. This group includes things like 401(k) accounts, 403(b) accounts, IRAs and qualified annuities. Why not? It’s because the taxing authorities look at this transaction and consider it to be a “complete withdrawal” of all of the funds in the account. So 100% of whatever amount you had in the account at that time will be legally declared to be income to you in that year and you’ll have to pay income tax on it, which could be huge hit to your income taxes that year.

You may have heard that you cannot fund your health savings account (HSA) into your trust. While that is true, there is a “work-around” for this. Instead of transferring ownership of the account to the trust, you can simply name your living trust as a beneficiary of your HSA.

While you can fund life insurance into your living trust, you may not want to and you may not need to. You may not want to because, in some states, transferring ownership of an asset like life insurance can reduce the level of creditor protection provided by the law. You may not need to because, much like HSAs, you can include your life insurance proceeds in the distribution instructions of your living trust simply by naming your trust as the beneficiary of the policy.

With all these things that don’t go into a trust, you may be wondering, “If I have these assets, does that mean I don’t need a trust?” No, it does not mean that! For many people, probate avoidance is a primary goal for their estate. While assets with beneficiary designations accomplish that, chances are that you have many more assets, some of which may be high-value assets, that do not have beneficiary designations attached to them and which would need to go through probate to be distributed without a trust.

Additionally, a living trust does much more than just avoid probate. Most observers believe that it is harder to challenge a living trust successfully in court than it is a will. A living trust can also help you avoid the need for a conservatorship if you should become mentally incapacitated. So, whether you’re planning for mental disability or planning to avoid a legal contest to your plan, a living trust can help with all of these goals that go beyond just avoiding probate.

This article is published by the Legacy Assurance Plan and is intended for general informational purposes only. Some information may not apply to your situation. It does not, nor is it intended, to constitute legal advice. You should consult with an attorney regarding any specific questions about probate, living probate or other estate planning matters. Legacy Assurance Plan is an estate planning services-company and is not a lawyer or law firm and is not engaged in the practice of law. For more information about this and other estate planning matters visit our website at www.legacyassuranceplan.com.