How Do You Fund a Trust?

Funding a Revocable Living Trust is critical to ensuring your estate avoids probate. Unfortunately in my line of work, I see too many trusts where nothing, or almost nothing, is actually funded in the trust. That is why I make sure at least every six months or so to post this chapter from my book Estate Planning Basics to make sure my clients keep funding their trust top of mind.

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We sat at the kitchen table reviewing their father’s trust. Mr. John Smith (not his real name) had passed on a week earlier, finally succumbing to cancer. While his children had prepared themselves, Mr. Smith had prepared even more. He had one of the best trusts around, created by a California attorney two years earlier. “My father wanted to keep settling things as simple as possible,” the daughter said. “That’s why he basically liquidated everything and put it into a checking account in the name of the trust.”

“That will really make things simple,” I said. “As long as all of the medical and other bills are paid, there’s no reason not to distribute the funds within the next few weeks. Are you sure that all he had was the one bank account and it was in the name of the trust?”

“Well, yeah,” the daughter replied. “Except for these three stocks he wanted to hold on to. They’re in his name, not the name of the trust… is that a problem?”

I tried not to sigh too visibly, realizing that while the trust could be settled in the next few weeks, it may be months or up to a year before the stocks were distributed through the probate process.

Once you have a revocable living trust in place, you have to make sure all of your assets work with your trust. In other words, you have to make sure your revocable living trust is funded properly. A revocable living trust will keep all of the assets in the trust from having to go through probate. Therefore, to avoid probate completely, you have to make sure all of your assets are in the trust or are set up to transfer into the trust upon death. Even with the best $5,000 to $7,000 revocable living trust package money can buy, without funding it properly, all you really have is an expensive Will.

Here is where many attorneys put one over on their clients when they are approached about putting together a revocable living trust. Rather than advise their clients on the funding of the trust, they simply put together the documents and say, “OK, you’re done. You have a revocable living trust.” But then someone passes on, and the trust becomes nothing more than a receptacle for assets after they go through the probate process. And that is where revocable living trusts can get a bad reputation.

Most of the problems people hear about revocable living trusts are just like the stories people hear about hospitals. There is nothing inherently wrong with hospitals. Hospitals and the people who work in them can save your life, help you recover and then release you from their care allowing you to have a longer or better life. But then there are the stories of medication mix-ups, surgeries happening on the wrong person or the wrong part of the body, or a host of other malpractice problems. But all of these problems stem from the practice of medicine being done poorly.

It is the same with a revocable living trust not being effective in doing what it is supposed to do—avoid probate, preserve privacy, lower costs and shorten settlement times. The main area where revocable trusts fall short is when assets are not set up properly to work in conjunction with the trust. And so the revocable living trust naysayers, who are mostly attorneys who do a lot of probate work (big surprise), are way off target when they suggest people not use revocable trusts at all. What they should be saying is if you have a revocable living trust, just make sure it is drafted properly and your assets are in place to take full advantage of it. After all, no one is suggesting just because there are mistakes made in hospitals that we should simply close them all down—we just need to make sure that things happen the way they are supposed to.

While each asset is a little different, there are three main kinds of changes that have to take place depending on the type of asset. If your revocable living trust was drafted properly and an “assignment of personal assets” or similar form has been used, then all of your personal assets like clothing, furniture and appliances are already in the trust. This even covers things like the food in the refrigerator and the change between the seat cushions. What we need to be concerned with are items such as real estate and timeshares, investment and retirement accounts, bank accounts and other assets that have some sort of title to them.

The first kind of change is re-titling an asset in the name of the revocable living trust. In short, you and your spouse/partner are changing these assets so technically you no longer own the asset but your joint trust does. But don’t worry. You still control everything in the trust and can still do everything you normally would do as if it were property owned by both of you. The second kind of change is making the trust the primary beneficiary in case you pass on. You still remain the owner on the account, but now when you pass on it can go directly into the trust without having to go through probate to get there. The third change is to make a person the primary beneficiary and the trust becomes the contingent beneficiary. In this instance you keep control of the account, but if you pass it goes to another person, namely your spouse/partner, and not the trust. If the other person passes on before you do, then it would go to the trust to be distributed. The most important thing is that all of these possible transfers happen without probate.

While there may be different permutations and exceptions, these are the three main kinds of changes that need to be done. We will now go through some specifics on these changes one at a time, discuss which assets require a specific method, and then go into some exceptions, future steps and maintenance. But first, here are a few basics regardless of what kind of change is made.

The Basics

Always use the legal trust name and the legal names of people. The name of the trust is typically found in the first few pages of the revocable living trust. We also prepare a report for our clients called “Property Title and Beneficiary Changes & Designations” and list the proper name of the trust on the first page. This typically reads something like “The Revocable Living Trust of Jessica Tate and Mary Campbell.” For a person’s name, if their name is John Wilkes Booth or Lee Harvey Oswald, you should not refer to them as Wilkee Booth or Ossie Oswald, even though that is how people generally know them. Always use the full proper name.

One benefit of working with an attorney who works closely with financial advisors is that the advisor will typically outline and assist with a lot of these changes for clients using the exact names and information, and will also work with an attorney for any legal documents needed to make these changes, such as drafting deeds.

Second, always look at what kind of asset or account you are handling and ask “have I paid income taxes on this yet?” This is actually a big consideration. Any account that is “tax-qualified,” meaning it is for retirement and you were able to put that money away without paying income taxes on it, should never be transferred directly into the name of the trust. If you do, then IRS regulations may treat that as if you had taken all of the money out in one year, and you are subject to taxes and possibly penalties. If you are in doubt, contact your attorney or tax professional before making any such change.

Finally, start with a list of all of your accounts and assets that have some kind of title to them and make sure you go through the list until all of the changes are completed.

Re-titling assets in the name of the trust

In some cases, re-titling an asset so it is in the name of the trust is the best course of action. This is certainly the case with real estate, and is best for mutual funds, savings accounts, checking accounts, money market accounts, and other non-qualified brokerage accounts. By non-qualified, I mean that you have paid income taxes on the money before you put it into the account. As a word of caution, unless you are working with an attorney who funds the trust as part of the process or works with a financial advisor who does, we encourage people to handle as many of the transfers on their own as they can to save on the costs of funding the trust. Our firm charges several thousand dollars extra to handle all of the funding, but most clients can handle these items with the help of their financial advisor. However, transferring ownership of real estate involves preparing a legal deed to make those transfers. Drafting a deed is something only a licensed attorney should do, so if this has not been taken care of by your attorney, contact him or her.

In making changes to accounts, the type of form you would need is probably titled something like a “change of ownership” or “change of title.” In any event, your financial advisor or personnel at the institution should know which form is required to change the ownership of the account in the right way. If your advisor does not know, contact your attorney and have him or her speak with the financial institution.

Changing the primary beneficiary

There are also some situations where changing the ownership is not as beneficial as changing the beneficiary. The best example is a life insurance policy. The most important part of the life insurance contract is who gets the proceeds. In this case, the trust is the right beneficiary. While it is possible to make the revocable living trust the owner, the paperwork is usually much more involved and has no added benefit. Instead, it becomes easier to keep your life insurance policy in your name and simply make your trust the primary beneficiary. Upon death, all it would take is a copy of the death certificate for the proceeds to pay into your trust.

Please also note at this point we are talking about situations that don’t involve estate tax problems. If you have large life insurance policies and may be subject to estate taxes, other steps can be taken to account for ownership of life insurance while saving estate taxes through an Irrevocable Life Insurance Trust, which is beyond the scope of this guide.

Changing the contingent beneficiary

Finally, there are a few situations where you want to keep ownership of an account, name another individual as the primary beneficiary, and then possibly list the trust as the contingent or secondary beneficiary. In all of these cases, you are naming a spouse or partner the primary beneficiary of an IRA, 401K or other tax-qualified account for income tax purposes, and then listing your living trust or named individuals as the contingent beneficiary. For married couples, there are special benefits regarding tax-qualified accounts in that the surviving spouse can do a “roll-over” when one spouse passes on, meaning placing the assets in the account into the spouse’s own IRA and then take the money out when he or she chooses. In doing so, there can be some considerable tax-deferred growth, but the main catch is this is only available to spouses right now.

We also recommend this same set up be done for tax-qualified accounts for domestic partners even though they are not married. Our reason for making this recommendation is the funds are still going to the person they want, and if that person passes on first, it will still end up in the trust to be distributed to other beneficiaries when the second partner passes on. Under some recent federal laws, domestic partners have the opportunity to defer income taxes and spread them out over ten years when they inherit their partner’s retirement account. Also, as a very recent change, if a same-sex couple gets married, then they have the same tax advantaged roll-over option as well but they must be legally married. (Be careful and consult your tax professional regarding any state level tax implications.)

Difficult items

And now, because we are not in a perfect world, there are a few items that present difficulties. First and foremost, there are automobiles. The main problem with handling automobiles, at least in North Carolina, is that auto insurance agents generally don’t understand what we are doing in setting up a revocable living trust, and so they feel compelled to say your car is now a corporate vehicle, therefore the coverage is much higher and your premiums will go up. There is also no way to put a transfer upon death beneficiary designation on a car title, and therefore there is no way to have the automobiles avoid probate without creating hassles during life. But as I tell my clients, as long as your trustee has the car keys and the car is registered and insured, it really doesn’t matter if it takes a few months for the car to go through probate.

The second item that creates some difficulties is CDs. And no, I don’t mean the nearly obsolete music format. Certificates of Deposit are typically registered in the owner’s name and can’t be changed until the certificates become due without having substantial penalties. Therefore, the advice our firm typically gives is to wait until the CDs are due, and then if you wish to keep the proceeds invested in CDs, work with the bank to re-title them in the name of the trust at that time. Also, it may be worth checking with the bank to see if it can somehow place a beneficiary designation on the CD. Then it is probably easier to simply list the trust as the primary beneficiary.

Finally, while this is not really a difficult step in initially funding the trust, a lot of my clients have had some difficulty in refinancing a mortgage once the land is in the trust. This is not a legal difficulty or even a financial difficulty. The fact is despite the large increase in the use of revocable living trusts over the past 30 years and more, a lot of mortgage lenders still panic when they see the property is in a trust. Don’t let their panic affect you. Typically, all that is needed is a few pages of the trust faxed to the lender, or in some rare cases, a letter from the attorney. If your lender is still in a panic or requires you to transfer your property back into your name before it will refinance, then it may be time to consider another mortgage lender. If not, then one deed must be created and executed transferring the land back into your individual name, and then a second deed should be executed after the refinancing is completed in order to transfer the property back into the trust.

We have gone over all of the different kinds of transfers, the different kinds of assets, what needs to be done to each, and even reviewed some trouble areas. If everything is done properly, your revocable living trust should now be complete and well-funded. But what happens next? As you go forward in life, there will be many opportunities to open new accounts, buy and sell properties, and make transfers. Each time you have a new asset with a title or account name on it, something needs to be done to make sure it works with the trust. In these cases, simply review this program again to see what needs to be done.

As a word of caution again about mortgages, if you are buying property in the future and will have a mortgage on it, it may be more convenient, and certainly less stressful, to initially purchase the property in your own name, wait about two weeks, and then transfer the property into the name of the trust. In general, this just makes things run more smoothly.

With most situations in this guide, we recommend you consult with an attorney who fully understands life and estate planning. However, with regard to funding your trust, you may receive even better help with the financial advisor the attorney works with.

Summary

The right revocable living trust can provide many of benefits, but the trust only works if it is properly funded. In general, assets have to be retitled in the name of the trust, set up so the account pays into the trust upon death, or set up so the account pays out first to a spouse or partner and second to the trust or another set of named individuals.

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If funding a Revocable Living Trust is something you want to learn more about, then check out the Trust Funding Series.