Setting up—and actively managing—a trust is more expensive and complicated than simply creating a will, but the many benefits can outweigh the time and money required.
Securing your assets is one of the most important things you should do as a high-net-worth individual. While it may be a morbid topic, estate planning should be an essential part of your financial planning strategy, ensuring your hard-earned wealth is distributed to your intended beneficiaries per your direction. Without a comprehensive estate plan, you run the risk of losing control of a significant portion of your assets. Additionally, your passing could prove costly for your loved ones.
Estate planning is complex—especially for individuals of high-net-worth. There is no single approach that works for every person. Your comprehensive estate plan may include your chosen beneficiaries, a letter of intent, a will, healthcare power of attorney, durable power of attorney, your chosen guardians, as well as a trust. Expert guidance is necessary to ensure every aspect of your estate plan is working together to secure your assets and meet your needs.
For example, if you create a trust as part of your estate plan, it is crucial that your will and trust are complementary to avoid any contestations. There are also strategies you can employ to avoid probate and reduce estate taxes. By enlisting the help of a reputable wealth advisory firm, you benefit from expert advice and guidance on the intricacies of estate planning. This ensures that the distribution of your assets goes smoothly, both during your lifetime (if you wish) and upon your passing.
What Is a Trust?
A trust is a legally binding agreement whereby a grantor (also called a trustor) selects a trustee to manage and distribute various assets to beneficiaries. The grantor may be a single individual, a married couple, or siblings. The trustee can be a family member, friend, or a professional third party. The beneficiaries can be friends, loved ones, charities, schools, and even beloved pets. The assets can be anything of financial value: real estate, business interests, cash, stocks, bonds and other investments. That rare coin collection you’ve been adding to for twenty years? That can be part of a trust.
What Is the Difference Between a Will and a Trust?
Both a will and a trust spell out what happens to your assets. But a will only becomes active after your death, whereas a trust is active from its inception until either a specified end date or once every asset has been distributed.
Both a will and a trust can be drafted well in advance of your golden years. In fact, many individuals of high net worth start their estate planning in their 30s or 40s to ensure their loved ones are covered in the event of an accident or major medical issue. With a trust, you can begin distributing assets during your lifetime, whereas a will only divides up and bequeaths your wealth after your death. Other important differences include:
- A trust can protect your assets should you become incapacitated, but a will only becomes effective in the event of your death.
- Wills are subject to probate—a process whereby a legal administrator reviews the will—but trusts are not.
- Because a trust isn’t subject to probate, it can protect the privacy of the beneficiaries, while a will becomes public record.
- Wills are more likely to be successfully contested.
- Some trusts offer tax benefits and protection from creditors, but wills do not.
For many high-net-worth individuals, having both a will and a trust is essential to estate planning. If there are any discrepancies between the will and the trust, the trust will take precedence.
Why Start a Trust?
Setting up—and actively managing—a trust is more expensive and complicated than simply creating a will, but the many benefits can outweigh the time and money required.
As noted, a will is subject to probate, which can be a long and tedious process. In some cases, probate can take 1 to 2 years and cost anywhere from 2-4% of your estate in attorney fees and court expenses. Probate also means the details of your estate—and who inherits what—all becomes a matter of public record. Setting up a trust avoids the probate process altogether.
Trusts also provide flexibility when it comes to asset distribution. You can arrange for the trust to dole out a lump sum all at once or distribute smaller amounts over an extended period of time. You can set up college funds explicitly to cover tuition and related educational costs, or you can specify that trust money only be spent on rent or mortgage payments.
Security is another reason to consider setting up a trust as it creates a legal entity that’s protected from creditors and other potential hazards. For example, pretend you’ve entrusted your nephew—a professional archivist—with the task selling your expansive art collection after your death and distributing the proceeds equally between himself, your children, and his siblings. He is only a third of his way through this task (and following your intentions to the T) when he gets divorced and his ex-wife claims the remaining collection is community property and she is entitled to half. These kinds of situations can be avoided when the assets are placed in a trust.
A trust is also a useful tool to ensure minors or other dependents are cared for. Most often, the typical distribution of assets goes to your living spouse and children when you die. However, if your children are not yet of legal age, their share of your assets would need to be managed by trustees. Only when your children reach legal age will they be able to access their trust fund. This prevents the mismanagement of funds and provides your beneficiaries with extra long-term security.
Types of Trusts
There are many kinds of trusts and each one has its own set of pros and cons. Knowing the different types of trusts you can choose from and what they entail is a key part of estate planning. You should, however, consult a knowledgeable financial advisor who can assess your unique situation and provide guidance as you explore your options.
Living Trust
Living trusts are developed by the grantor while they are still alive. For your estate to skip probate court, it must be part of a funded living trust. Unfunded living trusts do not have any power until they are loaded with assets. If you are only able to stipulate the transfer of assets to your trust through your will, your beneficiaries would still need to go through probate court.
A funded living trust’s strongest advantage is that it will help you avoid probate court. However, this means that you would need to add funds into the trust while you are still alive. This may be burdensome, so early planning and strategizing are recommended to make the process smoother.
Revocable and Irrevocable Trusts
Revocable trusts give the grantor the power to edit or revoke the stipulations of their trust as they please. This option is more flexible, allowing the trustor to change the distribution of their assets as time passes. For example, if the trustor wishes to allocate a larger amount of their assets to a specific beneficiary, they may do so by editing the stipulations of their trust.
Irrevocable trusts, on the other hand, cannot be altered once they are created. This means that whatever is drafted on the day of creation becomes set in stone. Individuals who are certain about the distribution and division tend to choose this type of trust because it prevents alterations and changes.
It is important to note that revocable trusts become irrevocable once the trustor passes because the trustor will no longer be around to make changes.
Funded and Unfunded Trusts
Funded trusts have assets in them, and these assets are typically transferred into the trust during the trustor’s lifetime. Unfunded trusts, on the other hand, only have nominal property in them. These trusts are often funded through the trustor’s will.
As mentioned above, funded living trusts allow individuals to avoid probate court. Because unfunded trusts only receive the assets upon activation of your will, your beneficiaries would still need to undergo the probate process to access your assets.
Other Types of Trusts
There are many types of trusts you can choose from according to your needs. For example, you could choose a charitable trust, which allow you to leave some of your assets to a charitable organization, a qualified terminable interest property (QTIP) trust, which give surviving spouses an income of sorts, or irrevocable funeral trust, which allow you to set aside funds to cover funeral expenses.
Other, more targeted types of trusts might include qualified personal residence trusts, insurance trusts, separate share trusts, and special needs trusts.
- Qualified personal residence trusts allow an individual’s home or property to be excluded from their estate. This may help beneficiaries if one expects the value of the individual’s properties to markedly increase over time.
- Insurance trusts are a specialized type of irrevocable trust. They work similarly to a life insurance policy and are not part of an individual’s taxable estate. Being irrevocable in nature, one cannot change the beneficiaries later. However, the proceeds of insurance trusts can pay for estate-related expenses once the individual passes.
- Separate share trusts allow one to customize a trust according to each beneficiary. For example, you could establish specific features for your spouse, while your children enjoy a different set of benefits. This type of trust gives more flexibility, and you get to distribute your assets among your beneficiaries in the way you think is best.
- Special needs trusts are another type of irrevocable trust. This type of trust allows you to provide income to an individual with special needs or a chronic illness. With a special needs trust, disabled individuals can receive income from your trust on top of public assistance like Social Security.
Key Tax Changes Affecting Trusts
Recently the government has been debating tax changes that would heavily impact the way trusts work. The current tax proposals primarily affect individuals of high net worth, as legislators suggest there should be an additional 5% tax for those who make over $10 million a year. For those who earn above $25 million, legislators are also proposing a surtax of 3%.
The proposed additional tax also affects trust income, gift tax, and estate tax. If your beneficiaries stand to earn $200,000 or more, they will be charged a 5% surtax. Legislators are also proposing that the tax exemption for gift tax and estate tax be lowered from $11.7 million to $6 million. If implemented, these new laws will have a direct impact on the management of common trusts.
However, nothing is certain yet. It is impossible to determine what changes might be made as no laws have been passed, but a capable advisor can help you anticipate possible scenarios and the appropriate strategies to address them.
Preparing for Life’s Twists and Turns
No one knows what the future holds, and trusts are a key part of estate planning: they provide legal protection for your assets, ensure distribution is handled per your direction, and can help reduce inheritance and estate taxes.
Which kind of trust is best for you and your family? What other provisions do you need to make? All these questions are best answered by an experienced financial advisor from a reputable firm like Polaris Wealth Advisory Group. An agile wealth management team will not only develop an estate plan that addresses your concerns, but will also assist with retirement planning, investment management and asset protection.
Reach out to Polaris Wealth today to secure your future.
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