Trusts play a critical role in estate and retirement planning by making it easier to pass down assets, minimizing your tax burden, and offering more control over the entire process. However, trusts are not a “one size fits all” solution, as there are certain assets that you should not include in a trust.
This article will break down the basics of which assets you should and should not put in a living trust. However, it’s best to speak directly with a financial advisor who can provide more specific advice.
To learn which type of assets make the most sense to add to a trust, please contact the ARQ Wealth team by calling (480) 214-9572.
What Assets Should Not Be in A Trust
The assets listed below are general recommendations. The best financial plan for you will depend on a wide variety of factors, and we recommend speaking directly with an advisor.
Individual Retirement Accounts: IRAs and 401(k)s
You can legally transfer assets in your IRA, 401(k), or other qualified retirement accounts into a trust. However, doing so will technically count as a withdrawal from the account.
This means that you will have to pay the relevant taxes and penalties:
- Taxes: Transferring assets into a living trust often incurs a tax bill, similar to a withdrawal. The bill will depend on the type of account, your income, and other factors.
- Potential Penalties: If you’re under 59 ½, you’ll also need to pay an additional early withdrawal penalty, which is currently 10%.
If it’s absolutely necessary for you to transfer your retirement account, then you can still do so. Just be prepared to pay the relevant taxes and penalties.
In this scenario, instead of transferring the assets, a better option is usually to name the living trust as a beneficiary of the retirement account. This way, the funds will transfer directly to the trust after you pass.
Note: Trusts technically count as separate legal entities, which is why you have to pay taxes if you transfer your retirement account.
Health Savings Accounts and Medical Savings Accounts
Health Savings Accounts (HSAs) and Medical Savings Accounts (MSAs) offer a way to use pretax income to cover medical expenses. However, HSAs are typically for individual use only. This means they cannot be transferred to a trust if it has joint ownership.
Instead, it’s usually best to name the trust as the beneficiary of your Health Savings Account.
Life Insurance Policies
Life insurance policies can be a key pillar of a comprehensive retirement plan, helping ensure your heirs and dependents are financially protected if you pass away. However, there are a few reasons why you may not want to add a life insurance policy to a trust:
- Your assets won’t be protected: Living trusts don’t protect assets from creditors, so your life insurance proceeds could still be reclaimed if you pass away with debt.
- It could trigger a tax bill: Naming a living trust as a beneficiary to your life insurance policy could trigger state and/or federal estate taxes, if your policy payout and estate are large enough.
- It could delay the disbursement of funds: Adding your life insurance policy to a trust will likely create a few additional legal requirements that could delay the disbursement of funds after you pass away.
Instead of adding a life insurance policy to a living trust, it may make more sense to open an irrevocable life insurance trust (ILIT). An ILIT is a trust created during the insured’s lifetime for the specific responsibility of owning and controlling a term or permanent life insurance policy.
These types of trusts have more flexible rules and are able to manage and distribute the proceeds that are paid out upon the policy owner’s passing, making them a preferred option over living trusts.
Vehicles
If your vehicle is under a certain value, then it can likely skip the probate process and pass directly to your heir.
In this case, adding the car to a trust would create a handful of unnecessary steps that could complicate the title transfer and registration process. Adding everyday vehicles to a trust could also complicate matters if you change your mind and decide to sell the vehicle, as you’ll have to go through the process of removing it from the trust.
Instead of a trust, you can consider just adding the vehicle to your will.
Note: High-value collectible cards are an exception. If you think that your car will continue to increase in value, then it may make sense to add your car to a trust. This is usually only the case for rare or collectible cars.
Social Security Benefits
Social Security benefits must be paid directly to the beneficiary, so they are not legally eligible to be transferred to a trust.
What Assets Should Be in A Trust
The assets listed above are generally considered exceptions to the rule, as most assets can—and often should—be transferred to a trust.
Common examples of assets that you should consider putting in a trust include:
- Brokerage accounts (not including qualified retirement accounts)
- Mutual funds
- Real estate
- Bonds
- Annuities
- Certificates of Deposit
- Qualified annuities
- Tangible personal property
- Individually-owned checking or savings accounts
Adding these assets to a trust can help them avoid the probate process while giving you more control over how and when they are distributed to your beneficiaries.
What is a Trust?
A revocable living trust (also known as a living trust or revocable trust) is a legal arrangement that gives someone else the power to make financial decisions on your behalf in the event of serious injury, illness, or death. This financial tool helps you retain control over the distribution of your assets after you pass away.
Trusts are often confused with wills, but there are crucial differences between these two estate planning tools. In many cases, people will choose to have both a will and a trust as these tools serve different purposes.
There are several reasons why people use a revocable living trust:
- Skipping the probate process: Probate is the time-consuming, court-supervised process of validating a will or determining how to distribute assets if there is no will. Trust assets are typically allowed to skip this process and pass directly to your beneficiaries. Without a trust, your assets could end up in probate for months or even years.
- Control over asset distribution: Trusts give you more control over how, when, and to whom your assets are distributed.
- Privacy over your affairs: Trusts allow you to maintain a level of discretion over your estate, which is important to many people. This is mainly because trusts help you avoid probate court, which typically becomes public record.
There are plenty of other reasons why people leverage trusts. To help you find out if a trust is right for you, learn more about the pros and cons of trusts.
Final Thoughts: Planning Your Retirement and Estate
Navigating the estate planning process can be highly complicated, especially for larger estates.
Trusts play a vital role in this process by helping your assets pass smoothly to your beneficiaries and providing flexibility over how your assets are managed and distributed (such as delaying the distribution of assets to minor children until they come of age).
Unlike wills, which go through public probate court, trusts allow your estate to be settled privately and often more quickly. They can also be tailored to meet specific investment goals. However, this immense amount of flexibility a trust offers also makes the estate planning process more confusing.
This is why it’s so important to speak directly with a qualified financial advisor who will be able to provide advice that’s tailored to your specific goals, alert you of any tax implications, and adjust your plan whenever there are updates to the tax code.
To speak with a financial professional, please contact the ARQ Wealth team or call (480) 214-9572.