Family Trust vs. Living Trust: What Are the Differences?

A family trust is generally a living trust created to hold and manage assets for the benefit of family members. A living trust, meanwhile, is a broader category that can name relatives, friends, charities or other beneficiaries. Both types of trusts are typically established during the grantor’s lifetime, and they may be revocable or irrevocable. When comparing a family trust vs. living trust, the main distinction is usually who the trust is designed to benefit.

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Benefits of Placing Assets in a Trust

When you place your assets into a trust, those assets generally avoid probate court after your death, provided you have properly transferred them into the trust. Avoiding probate shields your heirs from unnecessary and expensive court costs. Plus, it provides a layer of security, keeping trust assets out of the public probate process so your affairs can remain more private. While you are living, certain types of trusts can provide enhanced protection against creditors and lawsuits.

Trusts also allow you to distribute your assets to beneficiaries in any manner you see fit. You can even place conditions on the timing and manner of the distribution of your assets after you pass.

What Is a Family Trust?

A family trust is a legal arrangement that people often use to create a financial legacy for their loved ones. It is a often type of living trust that can be revocable or irrevocable, depending on the estate planning strategy you have in mind. Revocable trusts are changeable during the grantor’s lifetime, whereas irrevocable trusts are more permanent.

The main purpose of family trusts is to manage your assets on behalf of your beneficiaries. The conditions of a family trust are generally flexible, subject to applicable law, and distributions can be based on milestones you specify. For example, a beneficiary may receive a set amount upon high school or college graduation, marriage, a new baby or on a specific birthday.

It’s also possible to set up these trusts to take care of a disabled child or family member. Certain specially structured trusts may preserve a beneficiary’s eligibility for Medicaid or other means-tested benefits. However, family trust assets are not automatically excluded from Medicaid eligibility calculations. Whether assets count depends on the trust’s terms, the beneficiary’s access to the funds and applicable Medicaid rules.

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What Is a Living Trust?

A living trust is a formal legal arrangement that can eliminate the need for probate for assets properly transferred into the trust before your death. With a living trust, you can leave your estate to anyone you choose. This includes family members, friends, charities, schools, and foundations and even pets. You can also specifically deny an inheritance to anyone. By stating your wishes in clear terms, you can minimize the potential for people to contest the estate plan you have built.

Once you’ve set up your trust, it’s necessary to transfer your assets into it so later distribution under the trust’s terms is possible. Most people retain control of their trust throughout their lifetime, which is generally possible with a revocable living trust. You’ll name a successor trustee who is responsible for distributing assets to your named beneficiaries according to the rules of the trust.

Living trusts can save surviving family members money by avoiding probate fees. Certain irrevocable living trusts may also reduce estate or gift tax exposure, though living trusts can also be revocable. Revocable living trusts typically do not have the same tax benefits.

Family Trust vs. Living Trust: Key Differences

Members of a family whose assets are held in trust.

Family trusts and living trusts both offer protection and benefits for your assets. However, they have two key differences:

Who can benefit: A living trust can distribute assets to anyone the grantor has named as a beneficiary when they die. Beneficiaries can include family, friends, charities, alma maters and other eligible recipients, including pets. By contrast, family trusts are primarily for the family members of the grantor.
Level of family support provided: A family trust can have an extended lifespan, enabling it to distribute assets based on designated milestones (i.e., marriage, having children, etc.). It can also fund the care of a disabled loved one for the remainder of their life.

Should You Create a Trust for Your Estate?

Even if you don’t think you have enough money to worry about estate taxes, a trust can still be beneficial. Trusts can eliminate the need for probate for properly funded assets and can minimize the potential for heirs to contest your wishes.

With a trust, you can effectively control your estate “from the grave” by implementing rules for the distribution of your money after your death. Trusts can help you care for someone with medical needs for the rest of their life.

Trusts also control the distribution of your estate. For example, you can choose to give money to a beneficiary when they reach a certain age or life milestone, like graduating, getting married or having children.

How to Choose Between a Family Trust and a Living Trust

Deciding between a family trust and a general living trust will depend on your goals.

If your main focus is to avoid probate and keep your estate plan private and flexible, a revocable living trust may be the better option. It gives you full control of your assets during your lifetime and allows you to update beneficiaries and terms as your situation changes.

On the other hand, if your priority is long-term support for family members such as funding education, supporting a disabled dependent or preserving wealth across generations, a family trust may be more appropriate. Family trusts often have longer timelines and more detailed rules asset distribution.

In many cases, it’s possible to structure a trust to meet a mix of goals. A financial advisor or estate attorney can help you decide which approach fits best based on your family, financial situation and estate planning needs.

Tax and Asset Protection Considerations for Trusts

Revocable living trusts do not provide income tax benefits while the grantor is alive. All income generated inside the trust is reported on the grantor’s personal tax return. Further, assets in a revocable trust are still counted as part of the taxable estate. As such, while these trusts can help with probate avoidance and organization, they generally do not shield assets from creditors or lawsuits during the grantor’s lifetime.

Irrevocable family trusts operate differently. When assets are transferred to an irrevocable trust, the grantor generally gives up control. This can limit creditor access and may reduce the size of the taxable estate if the transfer meets applicable tax requirements.

Income generated inside an irrevocable trust is taxed either to the trust or to the beneficiaries who receive distributions, depending on the trust’s terms, tax classification and applicable tax rules. Certain irrevocable trusts are treated as grantor trusts, meaning the grantor remains responsible for reporting the trust’s taxable income. Because trust tax brackets are compressed, income retained in a nongrantor trust may be taxed at higher rates than individual income. Distributing income to beneficiaries can help manage this tax exposure.

Some family trusts also play a role in long-term care planning. Certain irrevocable trust structures may allow for the exclusion of certain assets from Medicaid eligibility calculations. For this to happen, the trust structure must meet meet strict regulatory requirements. You must also establish it well in advance of a Medicaid application. Rules vary by state and often require careful legal guidance.

Common Mistakes to Avoid When Setting Up Family or Living Trusts

Creating a trust is only the first step. Making a misstep during or after the setup process can undermine the potential protections a trust could offer.

Failing to Fund the Trust

The most consequential and most common mistake is creating a trust document without transferring assets into it. A trust that exists on paper but holds no assets offers none of the probate avoidance or distribution benefits. It’s necessary to retitle real estate into the trust’s name and transfer financial accounts or other assets using the appropriate ownership documents. Some accounts may instead name the trust as a beneficiary when that arrangement is appropriate.

An unfunded trust is generally unable to provide the intended probate avoidance benefits for assets that remain outside it.

Not Naming a Successor Trustee

A trust requires a trustee to function. If the original trustee becomes incapacitated or passes away without a named successor, the trust can become difficult or impossible to administer without court intervention. Naming at least one successor trustee, and ideally a backup to that successor, helps maintain continuity if the original trustee can no longer serve.

Forgetting to Update the Trust After Major Life Events

A trust reflects your wishes at the time it is created, but life changes. Divorce, remarriage, the birth of a child or grandchild, the death of a named beneficiary or trustee and significant changes in assets all create situations where the original trust terms may no longer reflect your current intentions. Reviewing the trust periodically and after significant life events keeps it aligned with your current wishes.

Assuming the Trust Covers All Assets

Retirement accounts, life insurance policies and certain bank accounts pass to beneficiaries through separate designations that operate independently of a trust or a will. It is crucial to review the beneficiary designations on these accounts alongside the trust. Otherwise, assets can end up in the wrong hands or create unintended tax consequences for heirs.

Using the Wrong Type of Trust for the Goal

A revocable living trust provides probate avoidance and flexibility. However, it offers no protection from creditors and does not reduce the taxable estate during the grantor’s lifetime. An irrevocable trust can provide creditor protection and estate tax benefits, but it generally involves restrictions on the grantor’s control. Further, it must meet applicable legal requirements to provide those protections.

Choosing the wrong structure for the goal, such as expecting a revocable trust to shield assets from a lawsuit, can leave significant gaps in the plan. These can be difficult to correct after the fact.

Not Coordinating the Trust With the Rest of the Estate Plan

A trust works best when it’s part of a coordinated estate plan. Ideally, this should include an updated will, powers of attorney and healthcare directives. A will that contradicts the trust’s terms, or a power of attorney that does not account for trust assets, can create confusion and disputes among family members at the worst possible time. Reviewing documents collectively reduces the risk of gaps or conflicts between them.

Bottom Line

Creating a trust is an estate planning strategy that can help protect your assets and reduce gift and estate taxes.

A family trust is generally a type of living trust, rather than a separate legal structure. Whether you need a revocable or irrevocable trust depends on your assets, goals and family situation. Choosing the appropriate structure can help you manage assets, provide for beneficiaries and address estate planning needs.

Tips on Estate Planning

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