Successful estate planning involves establishing tools that ensure how your properties will be distributed at death. One of these tools is a trust, which is a legal entity that controls and maintain property ownership.
Trust vs. Will
Trusts and wills are both estate planning tools that allow a grantor to pass assets to beneficiaries upon death. Your decision to choose one over the other depends on certain considerations:
One of the advantages of a trust over a will is that a trust allows you to avoid a probate, which can take a long time to complete, especially if there are inheritance conflicts. However, a will may be the better option if you live in a state where probate is not a burdensome or complex process.
If you have minor children, a trust allows you to create provisions that specify when a child will be entitled to any trust assets. If you have beneficiaries with special needs, it may be best to limit their access or control over their inheritance. In this instance, a trust can also allow you to control their use of the property.
It is more expensive to set up a trust than a will since a trust needs to be managed actively once it is established. Of course, a will can also be costly depending on how long and complex the probate process is.
Setting up a trust with tax planning provisions is the better option if the value of your estate is higher than the current estate tax threshold. Nonetheless, the threshold for estate tax changes frequently so check with the IRS to know whether or not you should be concerned about estate tax.
Trusts come in different types based on the specific need for which they were created.
A grantor creates a living trust during his or her lifetime by transferring properties to a trustee. In general, the grantor can change or revoke the trust until death, at which point the trust becomes irrevocable.
Also referred to as trusts under will, testamentary trusts are created by a will after the death of the grantor. A testamentary trust is established for various reasons, such as:
- To protect the financial future of a spouse through lifetime income provision
- To keep minors from outrightly inheriting property at the age of majority, which is typically between 18 and 21 years
- To ensure children from a previous marriage will get their share of the assets
- To provide for a special-needs beneficiary
- To entirely bypass the surviving spouse as a beneficiary
- To include a charity in estate planning
As the name implies, a revocable trust can be changed or modified by the grantor as long as he or she is living. The trust becomes irrevocable at the grantor’s death. A revocable trust is the other option apart from a marriage agreement for couples who want to protect their separate assets.
A non-modifiable or irrevocable trust cannot be changed once the trust is created.
Tax consequences of a trust
Some living trusts, such as those where the grantor and the beneficiary are one and the same retain the tax identification number of the grantor. Other trusts are considered separate from the grantor and, thus, need to obtain a federal tax identification number of their own. These trusts also need to file a yearly return, which may include income taxes.
If you decide that you need to establish a trust, be sure to contact a specialist to ensure that your trust not only offers the protection you seek but also meets the laws of your state. It may also be necessary to consider mediation if there are issues between the trustee and beneficiaries.