We don’t need to go into detail about how important homeowners insurance is. Hopefully, you already realize you should never go without it. Today, we’re here to talk about trusts and how (or if) you should adjust your homeowners insurance after a trust has been established.
Trusts are fiduciary arrangements that allow a trustee to hold assets on behalf of a beneficiary. There are several types of trusts and benefits vary, but they’re an attractive 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.
It is a relatively painless process to establish a trust – one that offers substantial benefits to your heirs that go well beyond the tax benefits.
Unfortunately, this presents new challenges when it comes to homeowners insurance and trusts. You need to know a few key facts before making insurance choices regarding your home, including how to properly insure it for the right amount of all around protection before transferring your home to a trust.
A good journalist or investigator knows about the 5 Ws. When you answer these questions, you gain a firm understanding of a situation. Let’s tackle the issue of homeowner’s insurance and trusts from this perspective, with a bonus question at the end to make sure everything’s covered.
WHO Is Covered by Homeowners Insurance with A Trust?
This is the big question. Too often, we receive notice of a claim only to find out we can’t honor it because of an issue with the “who” in a homeowners insurance policy. Insurance policies are worded very carefully. In your homeowners policy, it likely lists you, your spouse, and possibly family members as the insured parties. But when you place your home into a trust, you no longer have any insurable interest in the residence and, consequently, you’re no longer covered.
Here’s a scary example to consider. One night, you wake up to the thick smell of smoke in your home. You quickly jump into action, waking up your spouse, grabbing the dog and a few personal mementos, and getting out of your home as fast as you can. Luckily, a neighbor already called the fire department and they arrive a moment later. They’re able to put the fire out but several rooms in the home are damaged. You make a claim but are told the only thing that will be covered are your personal items. There will be no reimbursement for the damaged structure.
When putting your home in 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. We’ll go into more detail on how to do this in a bit.
WHAT Is Covered by Homeowners Insurance with A Trust?
If the insurance policy is updated properly, the homeowners insurance will cover the residence, the property inside, damage done to another person’s property, and liability issues that occur either on the property or off the property with covered items.
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 not insured. In most trust setups, it’s common for the original owners of the home to remain in it until they either willingly leave or pass away.
If the trustor accidently leaves the bathtub running and then heads out to run some errands, problems aren’t far away. As the water overflows and begins to seep through the flooring, the expensive wood panels start to buckle. The water also leaks to the living room downstairs, causing the ceiling to bow and ruining the expensive furniture below. Can you guess what’s covered?
If the homeowners insurance policy hasn’t been properly updated, only the furniture is covered. That’s it. The trustee is financially responsible to fix the home or take the financial hit.
WHERE Does Coverage Extend?
With a standard homeowners insurance policy, coverage extends throughout your home, property, and anywhere you take an insured item. For example, let’s say the trustor allows the neighbor to take their kayak out on the lake. But the kayak has a defect, leading to an accident that causes permanent damage. Is an incident like this covered?
It depends. Should the neighbor sue for damages, the owner of the kayak (the trustor) will be covered for litigation costs and possible settlement costs. But the trust will also be named in the lawsuit and unless they’ve been properly added to the policy, will be responsible for their own defense costs and possible damages.
WHEN Does Coverage Lapse, If at All?
If the policy is updated correctly, you shouldn’t experience any lapse in coverage. This is why it’s important that you discuss your insurance policy with not just your insurance broker, but an attorney experienced with trusts as well. Because the wording is so important in an insurance policy, a single error could end up costing you, as these examples show.
It’s also important to update your insurance policy immediately. Even though one benefit of establishing a trust is the privacy it creates, this privacy won’t do much good if the involved trustee loses out on the trust assets and their own financial stability due to lapses in coverage. Essentially, setting up a trust and updating the insurance policy should go hand in hand.
WHY Can’t A Policy Be Put in A Trust’s Name?
While switching the homeowner’s insurance policy to the name of the trust might sound like a good idea, the opposite is true. While the legal ownership of the property has changed, when an individual transfers their real estate property to a trust, there isn’t a significant change in the risks and hazards that property faces.
If your insurance is in the name of the trust, then you have no insurance protection for liability issues 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 – because the trust has been named the beneficiary of the 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 idea to protect not only the privacy of your heirs, but also the value of the property you leave to them. Unfortunately, there is no set in stone method of making sure all parties are protected when you put your home in a trust. The insurance industry is catching up to the demands, but until then, here’s what you need to do.
Continue your insurance coverage in your name as you have before the trust but name 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. Keep in mind that the wording on this needs to be very specific. Simply adding “trust” is not enough, as this is considered a “what” instead of a “who”. Only a “who” can be covered in a policy.
When a trust is properly added to your insurance policy, you still get the broad liability coverage you need along with the personal property protection for the contents of your home. In this situation, the trust is protected against liability issues that occur within the residence but left exposed to issues arising on vacant land or 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.
Despite the many benefits of establishing a trust, failing to do so the right way, with the proper insurance assignments all around, could have disastrous financial consequences that completely negate the purpose of establishing the trust in the first place.
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 and best-case scenarios with a knowledgeable insurance agent that has experience with homeowners insurance and trusts.