A will and a trust are two different estate planning tools. Consider a will like a high-level set of instructions for after you pass away. You generally use a will to name the executor of your estate and guardianship for your children. Although you can leave assets to your heirs in a will, it’s not an efficient way to do so, which is why many individuals utilize a revocable living trust. Unfortunately, trusts are often thought of as a tool for only the super-rich, which is one of many misconceptions about trusts that can make this planning strategy underutilized by the everyday affluent.
What is probate?
Probate is a legal process where certain assets that were owned in the individual’s name are distributed by the court. The court will use the will to help guide their distributions and other decisions. However, a will can be contested, so there’s no guarantee your wishes will be followed.
A retirement account won’t go through probate unless you didn’t name any (living) beneficiaries. Life insurance proceeds also skip probate if you name beneficiaries (assuming the beneficiary wasn’t your estate). If you have a payable on death (POD) or transfer on death (TOD) on your bank account, then it will generally bypass probate too. Typically, assets held jointly with rights of survivorship, community property, or tenancy by the entirety will also avoid probate if the joint owner is living.
All probate assets have to go through probate court before they’re distributed according to your will (if you had one) or at the court’s discretion. Because the probate process can be long and costly, many investors choose to avoid probate whenever possible.
A revocable living trust can help solve many of these problems
Using a revocable living trust instead of a will means assets owned by your trust will bypass probate and flow to your heirs as you’ve outlined in the trust documents. A trust lets investors have control over their assets long after they pass away.
Here are a couple of examples of how a trust can provide additional control and protection of assets after death:
- You and your spouse have two adult children, currently ages 20 and 22. You also have a taxable brokerage account worth $1.5 million. You could put the account in your revocable trust so after you died the account would first go to your spouse and then to your kids if your spouse is no longer living. However, rather than have your kids inherit the money outright, maybe you want to give them each half when they turn 25 and the rest at age 35. Perhaps you also wish to give the trustee discretion to make additional distributions to help pay for a wedding or education before reaching the age milestones. It’s totally up to you.
- Now consider the above example, but you and your spouse also have older children from previous marriages. Depending on your wishes and family dynamics, you may not wish to give your spouse full control over the brokerage account when you pass, fearing your kids from your first marriage may not receive an inheritance at all. In this scenario, a trust could provide options for you to ensure all your loved ones are taken care of.
Trusts can provide tax planning opportunities
Assets held in your revocable trust remain under your control during your life. Because of this, assets receive the same tax treatment as if held outside of your trust. At death, certain assets are still eligible for a step-up in basis, even if they’re held in a revocable trust at the time of your death.
Trust planning can also reduce estate tax. The individual federal estate tax exemption is $11.7M in 2021 and $12.06M in 2022, portable between spouses. A handful of states also have a state-level estate tax. Massachusetts has one of the lowest estate tax exemptions in the country—currently $1M—and unlike the federal exemption, it isn’t portable. Using a credit shelter trust or marital trust after the passing of the first spouse can preserve the exemption.
In this example, assets up to the exemption amount ($1M) flow from a decedent’s living trust to a credit shelter trust. Any remaining assets would flow to another trust, such as a family trust. If the surviving spouse died later in the year, the credit shelter trust would generally not be included in the taxable estate. This can reduce or eliminate estate tax at the state level altogether, if the remaining gross estate is $1M or less.
Final word on trusts
Trusts can be a powerful tool to help you accomplish a wide range of goals during your lifetime and long after. Like the rest of your estate and financial plan, periodically revisit the strategy with your attorney to ensure alignment with your current situation, goals, and laws. As evidenced recently with the passing of the SECURE Act, legislative changes do happen which may require you to revisit your plan. For many investors, the relatively small amount of additional upfront work and cost to set up and fund a trust is well worth the benefit to you and your loved ones down the road.
Important disclosure: The material in this article is intended to provide generalized information only as to some of the financial planning considerations regarding trusts and should not be misconstrued as the rendering of personalized legal or tax advice. We strongly recommend you consult an attorney to discuss your personal situation and estate planning needs. Darrow Wealth Management offers Private Wealth and Asset Management to individuals and families; we do not provide legal or tax advice.
This article was written by Darrow Advisor Kristin McKenna, CFP® and originally appeared on Forbes.