So, you finally sat down to start your estate plan but have heard so many conflicting points about wills and trusts that you don’t know where to start. If you are choosing between a trust and a will, you’re not alone. One of the biggest reasons people choose a trust is because it eliminates the need for litigation and the court process. If you leave just a will behind, you must appoint someone as the executor to fulfill your wishes. They, in turn, will need to file a petition in court to open your estate and to have court-ordered authority to act as executor. Courts are known for being slow, causing inheritances for named beneficiaries to drag on due to the court’s backed-up calendar and procedures. Some jurisdictions only have a few court dates designated for probate matters, and setting the hearing on a day that all interested parties are available can feel like a game of Tetris. Not to mention, if you own real property in one state but have resided and passed away in another, this can bring the need for multiple states’ courts to be involved.
To add to this chaos, most of us have that one family member who likes to make things difficult, and one problematic heir can further slow things down by filing counter petitions, motions, etc. The judge will assume everyone has an interest until the executor proves otherwise, so it is not as easy for your executor to shut down meritless arguments from your crazy cousin Chrissy as you may think. One must also be aware of the public aspect of litigation. You or your family may not want your business laid out in a courtroom for others to hear. One of the biggest downfalls of probate cannot be corrected—that you are not there to defend yourself. As the deceased person, you have no control over what happens in court. You are left to hope your will was done correctly, that the executor found the original, and that all is done right by you.
Additionally, the judge can put heavy burdens on the executor, such as securing a bond, completing an inventory, and performing annual accounting. Although these are important safeguards, they make your executor’s life difficult during an already challenging time. Depending on your jurisdiction, the probate court system may not be the most sophisticated. This can lead to complex issues not being handled properly, necessitating an appeal to a higher court. As one can see, leaving just a will can trigger the need for litigation, and the litigation process can be stressful and costly, putting a heavy burden on the executor and the estate. Although a will is much simpler and less expensive to set up than a trust, it may cost much more money on the back end.
How do I Leave Assets to a Minor Child?
If you wish to leave a minor child assets in your estate plan, the Uniform Transfers to Minors Act (UTMA) is something with which to be familiar. UTMA works in correlation with the Uniform Gifts to Minors Act (UGMA) and allows assets such as cash, real estate, bonds, etc., to be given to a child, but appoints a custodian to manage the asset until the child reaches a certain age of termination. That age is state-specific, but most states set the age at 21. If you are not confident that your child will be financially responsible enough to manage the assets at 21, you may want to set up a trust for the minor, allowing you to select an age older than your state sets. If you are comfortable with the state-set age, you can easily add UTMA language to your will. One pro of UTMA is that there are no federal taxes on gifts to minors under a $15,000.00 cap. You must file a gift tax return if the assets are more than $15,000.00. However, one con of UTMA is that these assets will be considered if a child applies for financial aid for college and may cause them not to qualify based on the value of the assets. In addition, the income on a UTMA account is subject to tax, although most often at the child’s tax rates and income thresholds, which can be advantageous compared with your tax bracket.
When choosing the custodian of the child’s property, it should be someone financially responsible, trustworthy, and close to the child. Choosing someone who understands the child’s needs is very important as the custodian will have the authority to spend and invest the assets for the child’s benefit until they reach the age of termination. Most often, it would be whoever is left to be the child’s guardian, but it does not have to be. If you appoint a person other than the guardian to be the custodian of the assets, then it is important to choose two people who will work well together. If they do not see eye to eye, your child may end up stuck in the middle of litigation.
Which Trust Should I Trust?
Once you’ve created a trust, you must determine whether you need a revocable or irrevocable trust. Revocable trusts are also called living trusts and are the most common of the two. Revocable trusts can be modified by the grantor at any time during their lifetime and are simpler to set up as opposed to an irrevocable trust which cannot be altered and is more complicated to set up. It varies on state laws, but typically if a grantor wanted to change a beneficiary or take out an asset, it would require a court order or 100% agreement among beneficiaries for that change to be allowed. The grantor relinquishes a lot of control in an irrevocable trust. However, there are good reasons to go that route. In a revocable trust, the assets are generally vulnerable to creditors, so if the grantor is sued and a monetary judgment is entered, the assets in the trust may be gone after satisfying the judgment.
In contrast, the assets in an irrevocable trust are protected against creditors. Another key reason an irrevocable trust may be best is that there is no estate tax upon the grantor’s death, nor is there income tax for the grantor on any income the trust may generate. Finally, if you choose to set up an irrevocable trust, you will need to feel very safe and secure with your trustees, and you will need to be confident you do not need to access the assets prematurely, as you will have lost the freedom to do so.
Once you’ve decided which type of trust you wish to create, you must appoint a trustee. This person can manage your assets and make distributions to your named beneficiaries. Remember, as stated above, with a proper trust, there will not be court involvement which means this person will have no court oversight in how they do their duties as trustee—choose wisely! Most people will name themselves trustee during their lifetime and call upon someone else to be appointed at their death.
Revocable and irrevocable trusts also have different income tax consequences during the grantor’s lifetime. Revocable trusts typically are “grantor” trusts, where the income is taxed to the grantor for federal tax purposes. Irrevocable trusts, however, are treated as separate taxable entities for income tax purposes. They file their own tax returns (on IRS Form 1041) and pay tax at individual tax rates but at different, smaller tax brackets. For instance, in 2022, a trust with an income of $13,451 or higher will pay income tax at the highest rate of 37%. Careful planning, including distributing income to a beneficiary, can minimize entity-level tax for trusts.
Trusts allow you to plan for unique scenarios that a will cannot sufficiently account for. A special needs trust, for example, allows you to leave assets for your child if they are disabled without the assets being considered when they apply for disability benefits such as Supplemental Security Income. This would be a reason to elect a special needs trust instead of UTMA. In addition, there are many other niche trusts, such as generation-skipping trusts, which help you steer clear of some taxes, and domestic asset protection trusts, which help you shield your assets from creditors while maintaining some of the benefits of a revocable trust.
As stated above, a trust allows for more privacy than a will because the heirs are not entitled to an accounting, and the need for litigation is unlikely. If, however, there is a challenge to a trust (the validity of the document itself, how the trustee is performing their duties, etc.), in most jurisdictions, it would be handled in a chancery court, which is usually a more sophisticated court than a probate court, where a challenge to a will is likely to a be brought. Additionally, as mentioned a few times above, there are tax benefits that you can take advantage of with certain trusts that are just not available with a will.
Will I Also Need a Will?
After reading all the above, you may wonder why you even have a will. Well, there are benefits of having a will alongside your trust, and you may have a simple enough estate that a will suffices. Even if you have a solid trust, a will is a document where you can put in your last wishes for items, such as whom you’d like to be the guardians of your children. Remember that your named guardians will still have to file a petition for guardianship, but your will is essential in this instance. The court’s involvement in probating a will may seem like a con, but it can also be a pro if you know that your beneficiaries may squabble. You may want your executor to secure a bond and submit an accounting for transparency. Also, some people do not like the idea that they lose title or ownership of their property when it’s in a trust and can create wills that fund a trust after their death. Even a grantor who funds a trust during their lifetime can benefit from a “pourover” will that transfers assets they did not convey to the trust during their lifetime to the trust. Finally, a will is going to be quite a bit more affordable on the front end, but potentially quite expensive on the back end with litigation. The most complete estate plan would include both a will and a trust.
Where Does my Life Insurance fit Into all of This?
It is important to remember assets are often left to the side during estate planning. For example, if you are looking at your estate and you are worried that you will not have much to leave to your children, do not forget about life insurance. A life insurance policy is an asset, and if you have correctly named your beneficiaries on your policy, then it does not need to be included in your will, and you can choose to leave it out of a trust as well if you like.
Trust me; You Will Need to Start Planning Now!
Lastly, the most important thing is to start! Most of us think if we are young, we do not need to worry about this. That could not be further from the truth. It is not pleasant to think about, but something could happen to you at any time. It’s a smart idea to create your trust now and as your estate gains assets, add them to your trust. Your loved ones will thank you later.
