Warning this article starts off dry & boring but if you hang in there it gets better with fireworks, fire, and other mayhem.
First things first. What is a Trust?
Basically, here are some layman’s definitions. A trust is a legal document that can be created during a person’s lifetime and survive the person’s death. It can also be created by a will and formed after death. Keep in mind once assets are placed into the trust they belong to the trust itself, not the trustee (person). Those assets then remain subject to the rules and instructions of the trust contract. Essentially, a trust is a right to money or property, which is held in a “fiduciary” relationship by one person or bank for the benefit of another,
The trustor or grantor is the one who contributes property to the trust and started it. The trustor is often also the primary trustee in living trusts. The originator is another fancy term for the person who started or created the trust. When the trustee passes away or becomes incapacitated the successor trustee becomes the executor of the trust and is responsible for managing the trust and its assets.
The trustee is the one who holds title to the trust property and manages the trust and is usually appointed by the trustor. The beneficiary is the person who receives the benefits of the trust.
While there are many different types of trusts, all with varying benefits and purposes the two basic types of trusts are revocable and irrevocable.
An irrevocable trust is one that cannot be altered, changed, modified, or revoked after its creation. Once a property is transferred to an irrevocable trust, no one, including the trust maker (a.k.a originator, grantor, trustor) can take the property out of the trust. An example of this would be survivorship life insurance purchased specifically for estate tax planning purposes of a large estate. The death benefits of the life insurance could be held by an irrevocable trust.
Revocable Trusts are created during the lifetime of the trust maker (a.k.a originator or grantor or trustor) and can be altered, changed, or revoked entirely. Often this type is called a living trust, these are trusts in which the grantor:
- Transfers the title of a property to a trust
- Serves as the initial trustee
- Has the ability to remove the property from the trust during his or her lifetime
Basically, a living trust is a legal document that states who you want to manage and distribute your assets if you’re unable to do so, and sets up who receives which assets when you pass away. Having this type of trust helps communicate your wishes so your loved ones aren’t left guessing. Typically, a revocable trust will convert into an irrevocable trust upon the death of the trust maker when assets are fully transferred. Once ownership of the home is in your trust, it can pass to your beneficiaries without having to pass through the lengthy time and expense of probate. Because trusts are private, they are also useful in preventing the details of your estate to be revealed to outsiders.
Sounds great! However, putting your home in a trust can also complicate your insurance. Yes, we agents seem to always be the bearer of bad news. It is very important that you make your insurance agent, or company (if you aren’t lucky enough to have an agent) aware you are either planning or, have already put your home into the trust so that it can be properly added to your home policy. Unfortunately, we often learn about a trust years after it was formed because the insured had no idea it could have any impact on their home insurance.
OK, so my home is in a trust. Why does that even matter? Let’s consider some reasons.
WHO Is Covered?
This is the big question. When you purchase a homeowners policy, you might think you are insuring your home, but you aren’t really. You’re really insuring yourself (or whoever owns the policy) against something bad happening to your home or at your home. (Keep in mind the bad has to be a covered peril because not all bad things are covered). When you throw a trust into the mix, you end up muddying the picture of who is an insured party and who isn’t. Too often, insurance companies receive notice of a claim only to find out they can’t honor it because of an issue with the “who” in the insurance policy. Insurance policies are worded very carefully and are legal contracts. Your homeowner’s policy likely lists you, and your spouse as the named insured parties. But when you title or place your home into a trust, you could end up no longer having any insurable interest in the residence and, consequently, end up not being covered.
Here’s a frightening example to consider. One night, you wake up to the smell of smoke in your home. You and your family quickly flee the home and call 911. The fire department arrives and is able to put the fire out. However, a large portion of your home has been damaged. You make a claim. The claims adjuster discovers the home has been deeded to your trust and informs you the only property the insurance company legally can cover are your personal belongings that were damaged. There will be no reimbursement for the damaged structure. That’s really stinky!!!
WHAT Is Covered?
If the insurance policy is updated properly, the homeowner’s insurance will cover the residence, the property inside for covered perils. It should cover the damage that is done to another person’s property and liability issues that occur either on or off the property.
Where it gets tricky though is making sure that all involved parties are simultaneously covered for these items. As demonstrated in our last example, it’s possible to live in a home that’s no longer insured because you have placed it in a trust.
Consider the example of the trustor vacationing. While away a pipe breaks and the home floods. Can you guess what’s covered?
If the homeowner’s insurance policy hasn’t been properly updated, only the furniture and other personal belongings are covered. That’s it. The trustor is financially responsible to repair the home on their own.
WHERE Does Coverage Extend?
With a standard homeowners insurance policy, coverage extends throughout your home, property, and the liability coverage is worldwide. For example, let’s say the trustor has their grandkids over for the Fourth of July and they shoot bottle rockets through the neighbor’s window leading to an injured neighbor and a damaged home.
It depends. Should the neighbor sue for damages, the named insured will be covered for litigation costs and possible settlement costs. But the trust could also be named in the lawsuit and unless they’ve been properly added to the policy, the trust will be responsible for its own defense costs and possible damages.
WHY Can’t I just put the policy into the Trust’s Name?
So it seems like the fix should switching the homeowner’s insurance policy to the name of your trust. Although this might sound like a good idea, the opposite is true.
If the named insured of the policy is the name of the trust, then you now personally have no insurance protection for liability issues that arise such as if someone becomes injured on the property. This means that you may still be held personally liable without the protection against liability judgments and legal expenses available under a standard homeowner’s insurance policy – all because the trust has been named the named insured of the home policy.
Then there is the issue of personal property. If the trust owns the home, but you own the contents, then you may be left out in the cold if something destroys the property and all the items inside (fire, tornado, etc.).
HOW Do I Make Sure We’re All Protected?
The truth is that trusts can be a great option for homeowners interested in passing along their homes and other property to loved ones and heirs without subjecting them to the public, expensive, and time-consuming probate process.
Ideally, the fix is that you continue your insurance coverage in your name and add the name of the trust as an “additional insured” entity. In other words, your home insurance policy should reference the name of the trust and the trust should be named on the insurance policy. The wording naming the additional insured on the policy needs to be very specific to keep your coverage intact and protect your trust’s interests.
Unfortunately, there is no set-in-stone method across all insurance carriers of making sure all parties are protected when you put your home in a trust. Some carriers will require that the grantor (trust maker) also be the primary trustee, named insured, and also be a resident of the home to be willing to add the trust as an additional insured. Others, won’t add the trust at all.
When a trust is properly added to your insurance policy, the dwelling will be covered and you will keep liability coverage along with the coverage for personal property. The trust should then also be protected against liability issues that occur within the residence. However, keep in mind the trust could still be left exposed to liability issues arising on vacant land or other properties that are rented to others. In order for the trust to be protected in these circumstances, you’ll need to work with your agent to come up with a plan that will accommodate the needs of the trust.
Don’t make insurance decisions concerning properties you’ve transferred to a trust, or are planning to transfer into one, until you’ve discussed your options with a knowledgeable attorney, CPA, and insurance agent that have experience with homeowners insurance and trusts.
WHEN Do I need to add the Trust?
Immediately. When you have titled your home or real property in the name of a Trust one of the first things you need to do is add the trust to your home insurance policy and any applicable umbrella policies. It’s important that you discuss your insurance policy with not just your insurance agent, but also an attorney experienced with trusts. Because the wording is so very important in an insurance policy, a single error could end up costing you.
Essentially, setting up a trust and updating the insurance policy should go hand in hand.