When it comes to estate planning, many people create a will to have their assets distributed after they pass away. But there’s another aspect of estate planning that may offer unique benefits to you and your family: a trust.
A trust is a legal contract, drafted by an attorney, with a named trustee who is responsible for administrating the trust and ensuring your assets are managed according to your wishes both during your lifetime and after your death. While people usually set up a trust during their lifetime, you can also stipulate in your will that that a trust is to be created upon your death.
Trusts can be established for a number of reasons. Among them:
- To manage and control spending and investments to protect beneficiaries from poor judgment and waste;
- To avoid court-supervised probate of trust assets and be private;
- To protect trust assets from the beneficiaries’ creditors;
- To protect premarital assets from division between divorcing spouses;
- To set aside funds to support the settlor when incapacitated;
- To manage unique assets that are not easily divisible, e.g. vacation homes, pets, recreational vehicles, mineral interests, timber and commercial real estate;
- To manage closely held business assets for planned business succession;
- To hold life insurance policies, pay premiums and collect the tax-free proceeds to care for beneficiaries, fund closely held stock redemptions or purchases, and provide liquidity to the estate;
- To provide a vehicle for charitable gifting that can reduce income taxes and benefit the settlor, his or her spouse and their children;
- To provide tools for Medicaid and means-tested benefit eligibility for the settlor, a surviving spouse and disabled children;
- To provide structured income to a surviving spouse that protects trust assets for descendants if the spouse remarries; and
- To reduce income taxes or shelter assets from estate and transfer taxes.
Benefits of a Trust
1. Trusts avoid the probate process
While assets controlled by you will have to go through probate in order to be verified and distributed according to your wishes, trust assets usually do not. A will becomes a part of public record, while a trust agreement remains private. When you establish a trust during your lifetime, a Living Trust, you only need to deal with your attorney and your trustee to execute the agreement.
By avoiding the probate process, you are not only able to keep your family’s financial matters out of the public view, but trusts are also typically quicker, simpler and less expensive way to have your assets distributed when you die. You may even decide to have your will state that any assets held outside of a pre-existing trust at the time of your death transfer into the trust when you pass away.
When you’re dealing with the death of a loved one – or the transfer of assets from one person to another – you likely want the change to be as seamless and private as possible. Creating a trust can help you achieve both of those goals.
2. Trusts may provide tax benefits
Trusts can either be revocable or irrevocable, essentially meaning that they can either be amended after they are created – or not. A revocable trust gives you the option to make changes to it after it’s signed, but, depending on its terms, it may or may not lead to tax advantages further down the line.
An irrevocable trust, usually cannot be changed after the agreement is signed – and setting up this kind of trust may bring about transfer tax benefits because you have transferred assets out of your estate. Contributions to the trust are generally subject to gift tax requirements during your lifetime. However, if certain conditions are met, assets placed in this type of trust (and appreciation on those assets over time) will be sheltered from estate tax after your death.
In addition to initial funding, you can make an annual exclusion gift (currently up to $15,000 for individuals or $30,000 for married couples filing a joint return) to an irrevocable trust each year without having to pay additional gift tax on that contribution. Speak with your trust administrator and attorney about whether a revocable trust and/or an irrevocable trust might be a good estate planning option for you and your family.
3. Trusts offer specific parameters for the use of your assets
Whether you establish a trust under your will and/or create a separate trust agreement during your lifetime, trusts give you the ability to truly customize your estate plan. You can include conditions such as age attainment provisions or parameters on how the assets will be used. For example, you can require the money in a trust to be given to your grandchildren only once they turn 18, and that the funds only to be used for college tuition. Or you might decide to limit how much money a beneficiary can receive from the trust each year if they’re someone who may need help managing the money.
Your trust administrator can help you talk through different possibilities and scenarios before your attorney drafts the actual trust document for your trust.
4. Revocable trusts can help during illness or disability – not just death
Wills only go into effect when a person passes away, but a revocable trust established during your lifetime can help your family if you become ill or unable to manage your assets. If that happens, your trustee can make distributions on your behalf, pay bills and even file tax returns on your behalf. You can choose ahead of time who to appoint (through the trust) to manage the assets.
Thus Living Trust can protect your family from undergoing a conservatorship. A conservatorship is when a court-appointed representative is given the authority to manage an incapacitated person’s financial matters for them. This feature of a Trust is especially comforting to families in times of difficulty since they do not have to worry about going to court and requesting access to the incapacitated person’s finances.
While no one likes to think about these scenarios, building in provisions like these can safeguard your family from having to make decisions without knowing your wishes during difficult times.
5. Trusts allow for flexibility
If you choose to create a revocable trust, you can change the terms of the trust agreement at any time by executing an amendment to the document. This allows you to be adaptable and flexible to life’s changing circumstances. Maybe down the line, you become involved in a charitable cause you’re passionate about. Or perhaps you have a new grandchild that you’d like written into the trust. If so, you can add them as future beneficiaries into your trust at that time.
Life can be unpredictable, but creating a revocable trust allows you to adapt your estate plans appropriately.
So there you have it. When you create a trust, you set up a plan to take care of the people you love when you’re no longer around or lack the capacity to assist them. Not only can a trust simplify the process of asset distribution, but it can also help you leave a lasting financial legacy.
Disadvantages of a Trust
While a Living Trust is often the best and most comprehensive ways to protect your family and assets, it does have some additional complexities. Most of the advantages of a Living Trust significantly outweigh any disadvantages, but you should still be aware of them when analyzing your Estate Planning options.
1. Additional Paperwork
One of the disadvantages of a Trust is the additional paperwork. In order to make a Living Trust effective, you need to make sure that the ownership of all the property in the Trust is legally transferred to you as the Trustee. If an asset has a title (real estate, stocks, mutual funds), you need to change the title to show that the property is now owned by the Trust. Let’s say you want to put your house into the Trust. To do this you need to prepare and sign a new deed to transfer ownership to you as trustee of the Trust. In the end, a little bit of additional paperwork and record keeping is worth much more than the time and money that will be lost in Probate, not to mention the stress that your family will have to go through to access your assets after you pass.
2. Maintain Accurate Records
Once you create a Living Trust you generally don’t need separate income tax records if you are both the Grantor and the Trustee. Any income you receive from property that you are holding in the Trust will simply be reported on your personal tax returns. However, if you transfer property in or out of the Trust, you need to keep accurate written records. This isn’t difficult, but it’s easy to forget if it’s been a few years since you created your Trust.
Structuring a trust
Trusts may be structured to achieve your specific goals, while providing tools for the trustee to balance those goals with prevailing investment and economic factors. The first step is to determine whether you will fund a trust now, make periodic gifts over time to the trust or wait to fund it at your death.
The most common choice is to use a revocable trust, sometimes called a living trust, as part of your estate plan. This type of trust is usually not funded until your death. It includes all your instructions for how you want your estate divided among your loved ones and how each person’s share or interest in the trust is managed, administered and distributed. If you have minor children, the trust usually dictates who will make financial decisions for them and provide funds to cover, at a minimum, their education and health costs until they are adults.
The typical living trust
There is a good reason that living trusts are easy to amend: As your children grow into adulthood, you often rethink your assumptions in light of actual life events. I recommend revisiting your estate plans at least every five years.
Here are two popular structures for a living trust that show how the trust may differ at different life stages.
For a working spouse with young children and a trust funded at death:
- The spouse is the successor trustee and primary beneficiary;
- The trustee may distribute income and principal to herself and the children;
- At the spouse’s death, a successor trustee may make distributions for the children, with an emphasis on education expenses through college;
- The trust distribution may be unequal;
- Once the youngest child is 25 years old, the trust divides into a separate trust for each child;
- At that point, the trustee may also make distributions to buy a home, fund a business venture or pay for expenses related to the child’s descendants;
- Each child has the power to withdraw one-third of the trust at age 30, one-half of the trust at age 35 and the rest of the trust at age 40; and
- The spouse has a limited power to appoint the trust assets to a new trust at death with completely different terms as long as it only benefits his or her descendants.
For a retired spouse with grown children, grandchildren and a trust funded at death:
- The spouse is the successor trustee and a primary beneficiary;
- The trust is the beneficiary of the settlor’s retirement accounts;
- The trustee must distribute all income and any required minimum distributions from the retirement accounts to herself and may distribute principal for herself and her descendants;
- At the spouse’s death, the trust divides into a separate trust for each child and for the surviving children of a deceased child;
- Each child is his or her own trustee and the trusts will last their entire lifetimes;
- Each child’s trust is a beneficiary of an equal share of the parents’ retirement accounts;
- The trustee may make distributions for any purpose to any beneficiary, but the named beneficiary is the primary beneficiary;
- The primary beneficiary may withdraw up to 5% of the trust each year for any purpose; and
- The primary beneficiary has a limited power to appoint the trust assets to a new trust at death with completely different terms as long as it only benefits his or her descendants.
These examples are for illustration only, are by no means the only options and won’t be suitable to your needs without expert legal advice. Regardless of your stage in life, consult an attorney and create your estate plan with a last will and a trust.
If your estate is likely to be greater than $1 million, includes real estate in more than one state or a family business, a trust is essential, and you should name a trust company as the successor trustee.