When we help a client review their complete financial picture, one of the areas we discuss is their estate plan. As part of that discussion, we often get the question “Should I have a living trust?”
Clients may ask because they have read an article that suggests that they should set up a living trust to avoid lengthy court dealings to distribute their assets to family members, or they may have talked with a friend who has a trust set up for children and grandchildren to use for specific purposes like education.
But like a lot of financial questions, there is no one-size-fits-all answer. A trust can be part of a well-designed estate plan, but not everyone needs one.
When we talk about trusts, typically we’re referring to living trusts, meaning you set up the trust during your lifetime and transfer ownership of your assets to the trust. With a revocable trust, you can retain control over the assets in your trust and make changes to it along the way.
In contrast, an irrevocable trust means you generally can’t make changes, but in exchange for less flexibility, these trusts tend to offer greater protections and benefits in areas such as taxes.
Trusts can be a powerful estate planning tool, but they can also lead to increased attorney’s fees, so they are oversold at times. To determine whether you should set up a trust, it helps to first understand what goes into a well-designed estate plan and see whether you’re better off passing on assets through other means.
Consider a Trust in the Context of an Estate Plan
A typical estate plan consists of a will, a living will, a durable power of attorney, and health care power of attorney. Your will is used to name the executor of your estate and to provide the details for how you want your assets distributed after death.
The living will details your desires regarding medical treatment when you are not able to express your consent. The durable power of attorney gives someone you choose the power to act in your place if you become incapacitated. That person typically has the power to act on your behalf for financial and legal responsibilities. The health care power of attorney gives a person the power to act on your behalf for medical issues.
Generally, the more straightforward your financial situation is, the more likely that having a will, living will, and durable power of attorney will be enough to cover your bases. You can also often directly designate beneficiaries for various assets such as bank accounts and retirement accounts.
With these documents in place, you can feel confident that your assets will be distributed according to your wishes and that you’ll receive the care you want in the event you need it, without having to add the expense and complexity of setting up a trust.
However, the more assets you have and the more complexity in distributing them, the more likely that establishing a trust can help you achieve your goals.
Simplify Asset Distribution with a Trust
Probably the most common use for living trusts is to avoid probate after your death. Assets that you place in the name of the trust will typically pass directly to your designated heirs, whereas assets that are distributed via a will go through probate, which is the court-supervised process of distributing your assets to your heirs.
Depending upon the assets that you own, probate can be costly and time consuming, accounting for several percentage points of your total assets and taking several months to even a couple of years to resolve complex cases.
If you have significant assets, want to specify how they should be distributed and used (e.g., for education or a certain amount at different times through a beneficiary’s life), or think your beneficiaries might challenge what’s laid out in your will, you may be better off setting up a living trust.
In particular, if you are in a second marriage or have a blended family, a living trust can smooth over what might otherwise become contentious issues. For example, your surviving spouse could disinherit your children, whereas a living trust would allow for you to provide lifetime benefits to your surviving spouse while still designating your remaining assets to your children. While a living trust can still be challenged in court, they generally provide for a more streamlined distribution of assets.
Furthermore, trusts remain private, whereas wills become part of the public record. If you’ve read stories about how celebrities’ assets were distributed after they passed away, that may be because their estates went through probate rather than being distributed privately according to the terms of a trust.
Even if you’re not a celebrity, if you’d like your estate to remain private, especially for your heirs’ sakes, then a trust may be a better option.
Financial Benefits of a Trust
In addition to streamlining the distribution of your assets and maintaining your family’s privacy, irrevocable trusts can also offer significant financial benefits, such as reducing estate taxes and shielding your assets from creditors. A revocable trust is less likely to offer benefits in this regard. You still control the assets, so revocable trusts tend to be ineligible for the same financial benefits.
For example, if you place assets in an irrevocable trust, you can help your heirs avoid or reduce gift and estate taxes. They would instead pay income taxes on distributions from the trust, rather than having the assets in the trust be counted as part of your estate.
In 2019, the federal lifetime limit for gifts and estate taxes is $11.4 million, meaning anything passed on beyond that amount will be taxed. Some states also impose estate taxes, so if you think your assets might exceed tax exemptions, your heirs could benefit from you setting up an irrevocable trust.
Similarly, if you place assets into an irrevocable trust, you can protect your heirs from having to use their inheritance to pay your creditors—but you can’t take this step with the intention to avoid paying existing creditors. This protection is more so in the event that later on in life you face an unforeseen situation where you have a debt, after assets have already been transferred to an irrevocable trust rather than being in your control and available to pay off your debt.
This can be a very complex situation, though, so you shouldn’t assume that your assets will be protected from creditors, and you should consult an attorney for more information.
To that point, because of the nuances of different types of trusts and their associated benefits that can vary by state, we always recommend that you meet with a qualified and experienced estate planning attorney to make sure that you have the documents you need to handle your affairs in the way that you want them to be handled, no matter what your financial circumstances are.
While nobody likes to talk about death and incapacity, it’s much better for you to do some estate planning and make decisions now while you can. If you don’t, the state you live in will have statutes in place to handle things for you. And you might not like their plan.
Schedule a 15-minute discovery call with a fee-only financial advisor to discuss your personal situation.