Most people like thinking about estate planning about as much as they like getting a root canal, but being smart about making provisions for what will happen to your money after you die can protect your family from a host of complications and financial difficulties at a time when they'll be least prepared to deal with problems. To make the transition as easy as possible, many people use living trusts to streamline the movement of assets and resolve many details long before they actually need to put their estate-planning strategies into action.
Despite their popularity, there is significant confusion about what a living trust actually is. So let's look at living trusts and what role they can play in your financial planning.
The basics of a living trust
A living trust is a type of trust that you create during your lifetime to hold your property. The key aspect of this trust, also known as a revocable trust, is that the person creating it maintains the right to make changes to the trust document or to eliminate the trust entirely. Often, the person who creates a living trust will also act as its trustee, and so for most practical purposes very little changes in the way one manages one's financial affairs with a living trust during the trust creator's lifetime.
Living trusts are useful in two primary situations. First, if an illness or injury leaves you incapacitated and unable to handle your financial affairs, then you can provide for a successor trustee to take your place and oversee the administration of the living trust. That ensures someone will take care of financial matters, such as paying bills and covering medical costs, while you're unable to manage your affairs on your own.
The living trust also includes instructions on what you want done with the assets within the trust upon your death. The living trust structure gives you a great amount of flexibility on how you want to distribute money or other assets to your loved ones, allowing you not just to make outright bequests to trust beneficiaries but also to hold on to assets long after your death and manage them for the benefit of family members and others who might not be financially savvy enough to handle the responsibility on their own.
The pros and cons of living trusts
Another major benefit of living trusts is that they generally don't require your family members to go through a costly and extensive court proceeding known as probate. If you use a will instead of a living trust, the probate proceeding is mandatory, and your will becomes a public document anyone can view. Even though a revocable trust becomes irrevocable after your death, its provisions remain private, and your successor trustee can manage your affairs without informing a court or making private matters known to the general public.
There are some downsides in using living trusts, though. Most estate-planning professionals charge more to set up a living trust than they do a will, although the savings later from not having to go through as extensive a court process can make up for the added up-front costs. In addition, using a living trust requires that you retitle your property in the name of the trust, which adds some administrative burden in making sure your real-estate holdings, financial accounts, and other assets reflect the trust's ownership. If you neglect this task, you can usually set up your will to transfer any forgotten property to the trust, but you lose the advantage of avoiding probate to the extent that your will has to government any property transfers after your death.
All in all, a living trust can be an excellent way of providing for your financial affairs and leaving a legacy for generations beyond your death.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.