A living trust, also known as a revocable trust, is an important tool for estate planning. When you create a living trust, you, as the trust's grantor, place your assets into the trust, but you retain the full benefit of those assets during your lifetime. Upon your passing, these assets are then transferred to the trust's beneficiaries.
Unlike in a fixed, or irrevocable, trust, the grantor in a living trust retains the right to change the terms of the trust, such as designating new beneficiaries. A grantor can make such changes at any time.
Primary beneficiary vs. contingent beneficiary
A living trust can have both primary beneficiaries and contingent beneficiaries. This is true both for a single-grantor trust and a joint living trust, a common option for spouses as it allows for multiple grantors. When setting up your trust, it's important to know the difference between the two types of beneficiaries, because it can affect who ultimately gets the trust's assets.
A primary beneficiary is any person or entity designated by the trust to receive its assets. In general, being a primary beneficiary means you receive distributions from the trust during the trust's existence. However, if it is a discretionary trust, the individual who both legally owns and manages the trust, known as the trustee, gets to decide when and to which beneficiaries distributions are made.
Unlike a primary beneficiary, a contingent beneficiary is a person or entity who becomes entitled to receive trust assets only if the primary beneficiary is unable or chooses not to. For example, if the primary beneficiary dies or can't be found, the contingent beneficiary becomes entitled to distributions from the trust.
All beneficiaries are subject to the same tax implications when receiving income from a trust. When a beneficiary receives a trust distribution, they must pay taxes on that income. The amount of tax depends on their personal tax rate.
Contingent beneficiary in life insurance
Designating beneficiaries for your life insurance is an important part of the estate planning process. While most people remember to designate a primary beneficiary, or person entitled to receive the policy's proceeds in the event of your passing, it's also important to choose contingent beneficiaries.
For example, if your primary beneficiary dies before you do and you don't choose another primary beneficiary before your own death, the proceeds will be paid into your estate if you haven't designated a contingent beneficiary as well. This is not an ideal situation, as the insurance proceeds are then subject to the probate process, which can be both lengthy and expensive.
Minors as contingent beneficiaries
Children are often designated as contingent beneficiaries under the terms of a living trust. In such cases, the trust pays out distributions, usually in the form of income, to the primary beneficiary, often the surviving spouse, and the children are entitled to any remainder of the trust on the death of that primary beneficiary.
Sometimes family trusts are structured so that children who are contingent beneficiaries become primary beneficiaries upon reaching the age of majority. However, in all cases where a minor child is a beneficiary of a trust, you should also appoint a legal guardian to manage whatever proceeds or assets the child receives until they are of legal age.
Contingent beneficiary's rights in a trust
Unlike a primary beneficiary, a contingent beneficiary does not have many rights when it comes to the trustee's management of assets. For example, unless a trust specifically gives them the right to do so, a contingent beneficiary usually cannot request an accounting, a process that lays out all the trust's financial transactions during any given period of time.
However, contingent beneficiaries do have the right to petition the court to have a trustee removed, which can happen if the contingent beneficiary feels that the trustee has not been properly managing the assets of the trust.
State laws and regulations can also have an impact on the rights of a contingent beneficiary. For example, some states might require trustees to give an accounting to both a contingent beneficiary and the primary beneficiary.
When setting up a living trust, it's always a good idea to designate one or more contingent beneficiaries. Doing so gives you peace of mind about what will happen to your assets after you pass away.