Here's What You Should Know Before Drafting and Funding a Trust
Establishing a revocable living trust is the bedrock of any well-crafted estate plan. However, its effectiveness depends entirely on how – and whether – you choose to fund it. This entails taking a thoughtful, strategic approach to determining which assets should be placed in the trust and how their ownership is structured.
Funding your trust should not be viewed as a simple paperwork exercise. Rather, it’s a critical process that shapes how your estate will be managed and distributed. Each asset presents its own set of legal, tax, and practical considerations, making it essential to evaluate not just whether it should be included, but how it should be titled to best serve your broader planning goals.
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One of the most commonly misunderstood aspects of funding a trust is the process of retitling real estate. This typically involves preparing and filing a quitclaim deed, transferring ownership of the property from its individual owner(s) to the trust.
Before taking this step, however, it is essential to consult with your mortgage lender and ensure that your loan does not include a "due-on-sale" clause. While many lenders allow for this type of transfer without accelerating the loan, especially when the trust is revocable and the borrower is the as the trust's grantor and trustee, it’s vital to confirm in writing that the transfer won’t inadvertently violate your mortgage terms.
Equally important is notifying your homeowners insurance provider that your property has been transferred into a trust. Doing so ensures that the trust is properly listed as an additional insured party on your policy. This step is crucial to ensure that any claims on the property are not denied due to a mismatch between the insured party and the titled owner.
When you place your home into a revocable living trust, the legal owner of record changes from your individual name to that of the trust. The reason this matters is that insurance contracts are built on a legal concept known as "insurable interest." Essentially, this means the policyholder must stand to suffer a direct financial loss from damage to or destruction of the property. If the trust is now the legal owner of the home, but the policy still names you individually, an insurer could argue that the named policyholder no longer has an insurable interest in the property.
Beyond real estate, the funding process often requires interaction with banks, brokerage firms, and insurance companies to update the ownership or beneficiary designations of accounts. Similarly, physical assets like vehicles or collectibles that you intend to pass on may require updated title or registration documents.
For those with assets in multiple states, such as vacation homes or rental properties, failing to place these properties into the trust can expose your estate to ancillary probate. This is a separate legal process in each state where property is held, potentially leading to multiple court proceedings, added expenses, and delays.
Another consideration in funding a revocable living trust is how it coordinates with your existing beneficiary designations. Life insurance policies and retirement accounts such as 401(k)s, IRAs, and annuities typically bypass the probate process entirely because they are governed by a contract between the company and the account owner.
Unlike other assets that are passed down through a will or trust, these accounts are distributed directly to the individuals or entities named as beneficiaries on the account itself. This makes it even more important to ensure your beneficiary designations are intentional and up-to-date, particularly if your estate plan involves the use of a trust to manage or distribute assets.
Creating a revocable living trust is only the beginning. If your assets are never retitled into the trust’s name, the structure remains hollow – leaving your estate vulnerable to the very probate process you intended to bypass. But even beyond the act of funding the trust lies a more nuanced task: deciding how each asset should be retitled, and whether doing so best serves your broader estate planning goals.
Not every asset needs to go into the trust, and for those that do, the mechanics matter. Aligning ownership titles and beneficiary designations with precision ensures that your trust doesn’t just exist – it works. True estate planning is not about generating paperwork; it’s about orchestrating a cohesive plan that protects your legacy and minimizes complexity for the next generation.
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Malcolm Ethridge, CFP® is the Managing Partner at Capital Area Planning Group, based in Washington, D.C. He is also the Managing Partner of Capital Area Tax Consultants.
Malcolm’s areas of expertise include retirement planning, investment portfolio development, tax planning, insurance, equity compensation and other executive benefits.
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Disclosures:
The information provided is for educational and informational purposes only, does not constitute investment advice, and should not be relied upon as such. Be sure to consult with your legal advisors before taking any action that could have tax and legal consequences.
Investments in securities and insurance products are:
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