The Legal Risks of Improperly Funding a Trust

Establishing a trust is a powerful way to protect your assets, ensure a smooth transfer of wealth, and avoid probate. However, failing to properly fund a trust can undermine its effectiveness and expose your estate to legal risks, unnecessary taxes, and probate complications. Many people mistakenly believe that setting up a trust is enough, but unless assets are correctly transferred into the trust, it may not function as intended.

If you need legal guidance to ensure your trust is properly funded, contact us by using our online form or calling 414-253-8500.

What Does "Funding a Trust" Mean?

Funding a trust means transferring ownership of assets from an individual to the trust itself. This can involve:

Retitling property and financial accounts in the name of the trust.
Assigning business interests, intellectual property, or personal valuables to the trust.
Updating beneficiary designations for life insurance, retirement accounts, and other payable-on-death assets.

If this step is skipped or done incorrectly, the trust may not control the intended assets, leading to legal and financial problems for beneficiaries.

Common Assets and How to Transfer Them into a Trust

Asset Type	How to Transfer to a Trust	Key Considerations
Real Estate	Retitle deed in the trust's name	May require lender approval; update property taxes & insurance
Bank Accounts	Change account ownership or set as POD/TOD	Some banks require specific trust documentation
Investment Accounts	Update account title or list trust as beneficiary	Confirm tax implications with a financial advisor
Retirement Accounts	Name trust as beneficiary (if appropriate)	Could affect required minimum distributions (RMDs)
Life Insurance	Name trust as primary or contingent beneficiary	Consider tax consequences for large policies
Business Interests	Assign ownership to trust or amend operating agreement	Review partnership agreements and corporate bylaws
Personal Property	Assign via trust document or personal property memorandum	Items of significant value may need appraisal
Intellectual Property	Assign copyrights, patents, or trademarks to trust	Ensure proper licensing and income distribution within trust

Legal Risks of an Improperly Funded Trust

1. Assets May Be Subject to Probate

One of the primary reasons people create a trust is to avoid probate. However, if assets are not transferred into the trust, they remain part of the probate estate and must go through court proceedings. This can cause:

Delays in asset distribution to beneficiaries.
Increased legal fees and court costs.
Loss of privacy, as probate records are public.

For example, if a person establishes a trust but forgets to transfer their home into it, the home will still require probate, defeating the purpose of the trust.

2. Increased Estate Taxes

A properly funded trust can help reduce estate taxes by structuring asset distribution efficiently. However, if assets are left outside the trust, they may increase the taxable estate, leading to higher estate tax liability.

This is particularly important for high-net-worth individuals or those with assets exceeding federal or state estate tax thresholds.

3. Loss of Asset Protection

Certain types of trusts, such as irrevocable trusts, are designed to protect assets from creditors or lawsuits. However, if assets are not properly transferred into the trust, they remain vulnerable to creditors and legal claims.

For example, if a person creates a Medicaid Asset Protection Trust but forgets to transfer their bank accounts into it, those accounts may still be considered available resources for Medicaid eligibility purposes.

4. Conflicts Among Beneficiaries

An improperly funded trust can create disputes among beneficiaries, especially if assets are unintentionally excluded or subject to probate. Common issues include:

Multiple claims on the same asset by different heirs.
Family members disputing whether assets should be in the trust.
Beneficiaries receiving unequal distributions due to mistakes in funding.

Such conflicts can lead to lengthy court battles, legal fees, and strained family relationships.

5. Trustee Liability for Mismanagement

A trustee has a fiduciary duty to manage and distribute assets according to the trust's terms. However, if a trust is improperly funded, the trustee may face:

Legal challenges from beneficiaries for failing to carry out the trust's purpose.
Personal liability for mishandling assets or failing to resolve funding issues.
Difficulties in accessing assets if they are not legally owned by the trust.

A trustee should regularly review trust funding and work with an attorney to ensure all assets are properly titled.

6. Failure to Accomplish the Trust's Goals

A trust is designed with specific goals, such as:

Providing for minor children or dependents.
Protecting assets from creditors or lawsuits.
Ensuring business continuity.

If funding is incomplete, these objectives may not be met, leaving beneficiaries in a difficult position.

Risks of Improperly Funding a Trust and Their Consequences

Risk	Potential Consequences
Probate Issues	Assets not in the trust may go through probate, causing delays and legal costs
Increased Estate Taxes	Untransferred assets may contribute to a higher taxable estate
Creditor Vulnerability	Assets outside the trust remain subject to creditor claims and lawsuits
Family Disputes	Beneficiaries may contest asset distribution if trust funding is incomplete
Trustee Challenges	The trustee may struggle to manage or distribute assets if they are not correctly transferred
Loss of Asset Protection	Certain trusts (e.g., irrevocable trusts) lose their legal shielding if assets are not transferred
Failure to Meet Estate Planning Goals	Minor children, disabled beneficiaries, or charitable organizations may not receive intended benefits

How to Properly Fund a Trust

To avoid the legal risks associated with an improperly funded trust, every asset intended for the trust must be correctly transferred. Here's how to ensure proper trust funding:

1. Real Estate Transfers

If real estate is meant to be part of the trust, the property title must be updated accordingly. This requires:

Preparing and recording a new deed that transfers ownership to the trust.
Updating mortgage lenders or homeowners insurance to reflect the trust's ownership.
Ensuring property taxes and exemptions remain valid under the trust's name.

Failure to properly transfer real estate could result in probate issues or property disputes.

2. Bank and Investment Accounts

Financial accounts must be retitled in the trust's name. This includes:

Checking and savings accounts.
Certificates of deposit (CDs).
Brokerage and investment accounts.

In some cases, financial institutions may allow a payable-on-death (POD) or transfer-on-death (TOD) designation instead of retitling the account. However, retitling provides the most comprehensive control under the trust's terms.

3. Retirement Accounts and Life Insurance Policies

Retirement accounts, such as 401(k)s and IRAs, cannot be directly owned by a trust. Instead, you may need to:

Update beneficiary designations to name the trust as a primary or contingent beneficiary.
Ensure this aligns with estate planning and tax strategies, as trusts may have different distribution rules for inherited retirement accounts.

Life insurance policies can be transferred to a trust, but it may have tax implications that should be reviewed with an attorney.

4. Business Interests and Intellectual Property

For business owners, transferring LLC interests, shares in corporations, or partnership stakes to a trust ensures continuity and prevents probate issues. Steps may include:

Amending the operating agreement to reflect trust ownership.
Executing a transfer document to assign ownership to the trust.
Obtaining consent from other business owners, if required.

Intellectual property, such as patents, copyrights, and trademarks, can also be assigned to a trust to protect future income streams.

5. Personal Property and Valuable Assets

Items such as artwork, jewelry, collectibles, and vehicles can be included in a trust by:

Executing a trust assignment document for valuable personal property.
Retitling vehicles in the trust's name, if state laws allow it.

Smaller personal effects that do not require formal title transfers may be covered by a personal property memorandum attached to the trust.

Common Mistakes in Trust Funding

Even with the best intentions, many people make critical mistakes when funding a trust. Some of the most common include:

1. Not Updating Titles and Deeds

Simply listing an asset in a trust document does not transfer ownership. Deeds, account titles, and legal documents must reflect the trust as the owner.

2. Failing to Reassess Beneficiary Designations

Assets like retirement accounts, annuities, and life insurance policies may override trust terms if they have conflicting beneficiary designations. Regularly reviewing and updating designations ensures consistency with your estate plan.

3. Overlooking Newly Acquired Assets

Any assets acquired after a trust is created must also be transferred into the trust. Otherwise, they may be subject to probate or unintended tax consequences.

4. Assuming a Pour-Over Will is Enough

A pour-over will is designed to transfer remaining assets into a trust at death. However, assets governed by a will must still go through probate, delaying distribution. Proper trust funding during life avoids this issue.

How an Attorney Can Help with Trust Funding

Funding a trust is a complex legal process that requires careful attention to detail. An experienced trust attorney can:

Identify all assets that need to be transferred.
Prepare necessary legal documents, such as deeds and assignments.
Work with financial institutions to update account ownership.
Ensure tax-efficient strategies for funding a trust.
Conduct regular reviews to keep the trust properly funded over time.

Contact a Trust Attorney for Assistance

Improperly funding a trust can lead to legal complications, unnecessary taxes, and probate issues-all of which defeat the purpose of having a trust. Ensuring your trust is correctly funded requires careful planning, legal expertise, and ongoing management.

If you need assistance funding a trust or reviewing your estate plan, contact us at Heritage Law Office or call 414-253-8500 to schedule a consultation.

Frequently Asked Questions (FAQs)

1. What happens if I don't fund my trust properly?

If a trust is not properly funded, assets intended to be controlled by the trust may remain in your personal name, making them subject to probate, estate taxes, and creditor claims. This can lead to delays, increased costs, and potential disputes among beneficiaries.

2. Can I add assets to my trust after it's created?

Yes, assets can be added to a trust at any time, but they must be formally transferred. This means updating titles, deeds, and financial account registrations to reflect trust ownership. Regularly reviewing and updating your trust ensures all intended assets are properly included.

3. Do retirement accounts need to be transferred into a trust?

Retirement accounts like 401(k)s and IRAs typically cannot be directly transferred into a trust due to tax rules. Instead, you can name the trust as a beneficiary to control distributions after your passing. However, this should be done carefully to avoid unintended tax consequences.

4. How do I know if my trust is properly funded?

A properly funded trust will have all intended assets titled in the trust's name or assigned to the trust. You should review:

Property deeds
Financial accounts
Beneficiary designations
Business and intellectual property ownership

Working with an estate planning attorney ensures no assets are overlooked.

5. Can a trust protect assets from creditors if it's not properly funded?

No, if assets are not transferred into an irrevocable trust, they remain in your personal estate and may be subject to creditor claims. Only assets formally placed into the trust receive the intended legal protections.