Trusts 101: Passing and Protecting Your Assets

“His will read as follows: Being of sound mind and disposition, I blew it all.”

— New Yorker cartoon, by Frank Modell (1972)

In terms of leaving property to your heirs, Frank Modell’s cartoon does not exactly read like an advertisement for a living trust rather than a will.

But it could.

People often think trusts are only for “rich people,” and it’s true that they are an effective way to avoid probate or estate taxes. Few people have estates taxes these days, though, and there are many ways to avoid probate. But trusts are still something that virtually everybody should consider. Properly structured trusts, after all, can be used to protect assets you leave loved ones from creditors and predators—folks like divorcing spouses and health care providers for catastrophic illness at the end of your life.

Trust Basics

There are, of course, many kinds of trusts—and not all apply. To begin with, know that a trust can be created at any time while you are still alive, and wills can also create trusts. A trust that is formed while its maker is still alive is a living trust, and the person who forms it is the trustee. A trust that came into existence upon the death of its maker is called a testamentary trust. In order to get assets into it, a testamentary trust must go through probate.

In their classic book, Loving Trust: The Right Way to Provide for Yourself and Guarantee the Future of Your Loved Ones, co-authors Robert A. Esperti and Renno L. Peterson point out that will planning is really death planning. Living trusts, in contrast, can deal with lifetime issues. The authors compare living trust planning to “babysitter instructions”—either for your own care or that of your loved ones. Unlike wills, living trusts deal with all of your property.

There are two kinds of living trusts: irrevocable and revocable. With an irrevocable trust, the maker cannot change the trust instructions after he or she has signed the trust. With a revocable trust, on the other hand, the maker can change the trust or even cancel it at any time—for any reason. After the maker has died, however, a trust cannot typically be either revoked or changed.

In general, we are believers in revocable living trusts. People change, and it is best to leave your options open—and change the trust accordingly, if you so desire. However, protecting trust assets from creditors or predators can be better accomplished with an irrevocable trust.

Is there a way to get “best of both worlds?” Perhaps. As Rick Randall, CEO of the National Network of Estate Planning Attorneys, explained in a recent Prosperity Podcast episode, there is a “loophole” by which even irrevocable trusts can be changed by a trusted third party, even after their death, in accordance with their intent. This is accomplished through the appointing of a trust protector, who ensures that the intent of a trustee is indeed carried out, whether they are still living or not. The protector can act according to the trustee’s wishes in many ways, such as replacing a trustee who is found to be untrustworthy, changing investment strategies to address economic upheaval, or altering other provisions of the trust, according to written instructions provided by the trustee during the creation of the trust. Read more about trust protectors in this Forbes article.

Also, keep in mind that you may have more than one trust. Therefore, a portion of your assets can receive the bulletproof protection granted to irrevocable trusts, while another portion of assets could be placed in a revocable trust.

The Challenge of Disability 

One reason that many people choose revocable living trusts is the possibility of disability. We are not talking about bare bones living trusts only designed to avoid probate, but rather trusts that include health care powers of attorney and living will instructions.

After all, let’s face it: there is a good chance that many of us will face disability. The pitfall of not having a living trust is straightforward indeed: If you can no longer take care of yourself, you may well not be able to decide who will take care of you—or where you will live. Nor will you be able to cash your own checks—or spend your own money. The probate court will do it for you. Older readers may remember the spectacle of Groucho Marx, who spent the last three years of his life in and out of probate court, living under the control of the court—and the glare of the press.

And if the court takes control, think about it. There are guardians, conservators, lawyers…. Even life insurance proceeds are controlled by the court, which will make sure that its court-appointed agents are paid—first.

Another concern with disabilities is that all of your assets could be eventually consumed until you are on Medicaid with few options or resources. With a trust, assets can be shielded from the healthcare system.

Protecting Assets from Creditors 

An irrevocable trust can protect assets from creditors—as long as it was not set up to defraud creditors. Property in a revocable trust, on the other hand, is generally not immune from creditors. There are ways, however, to circumvent this.

The basic rule of thumb: You cannot avoid your own creditors. So if you establish a revocable living trust, where you are both trustee and beneficiary, creditors can get at your assets.

If you die, however, leaving the assets of that trust to your children as the beneficiaries, creditors no longer have access to the trust’s assets. The critical difference here is who set up the trust on whose behalf. If the trustor (or maker of the trust) and beneficiary are different people, the assets are protected.

Example: Our colleague Rick Randall, likes to tell the school bus story.

Let’s say his wife hits a school bus filled with children, causing fatalities. A typical car insurance policy would not provide adequate liability protection for a situation such as this. And since the accident is her fault, whoever sues on behalf of the children will get all her assets, including any insurance he bought and put in her name. But if he put the insurance into a living trust for her, he can write the terms in such a way that she is able to maintain control and keep creditors and predators at bay from the funds in the trust. Her other assets—from her own earnings, for example—are not protected.

This principle can also be used for big medical bills at the end of life. Children, for example, can set up a trust for their parents so medical creditors cannot take all the assets in the trust—assets the children placed there. Parents, likewise, can establish living trusts for their progeny thereby protecting whatever assets are in the trust from creditors and predators. But remember: Your other assets are fair game.

Trust-worthy Help

Whether you decide to utilize a living trust or a testamentary trust, and employ a revocable trust and/or an irrevocable one, we recommend going through an estate planning process, such as the one implemented by attorneys who are part of the National Network of Estate Planning Attorneys (NNEPA). Too many people think of estate planning as something done in order to receive the end result of a document, but actually, it’s a process that, properly executed, facilitates ongoing participation, communication, and education for both trustees and beneficiaries.

The bottom line: You’ll want to make decisions that address your concerns and priorities with the advantage of expert advice, especially on the important topic of trusts.

And if you’re looking for trust-worthy assistance with your finances, we invite you to learn more about Partners for Prosperity and our unique investment philosophy. We call it “Prosperity Economics,” and you can learn more about it by downloading a complimentary ebook, Financial Planning Has Failed, co-authored by our founder, Kim D. H. Butler.