When most people think of the pillars of estate planning, the trinity of will, trust and advance care directives come to mind. While I think all of these instruments are good to have, not all are essential, at least at the beginning, to your estate plan. Specifically, a trust might not be worth it, especially for younger generation X and Y consumers that have just started building their assets. Today, I’m going to cover the basics of trusts and how to determine if you need one.
What is a Trust?
A trust is a legal entity that lets you dictate how you want certain assets distributed upon your death.
If you’re thinking it sounds very similar to a will, you’re right. Both documents help you make your wishes known. However, a trust usually only deals with specific assets, like a piece of property or life insurance, while a will governs everything else in your estate. Both documents go hand-in-hand to provide an efficient distribution of your assets at your death.
Trusts include many key components. You must have a trust objective. In other words, you will have a specific type of trust (e.g., Qualified Personal Residence Trust, Irrevocable Life Insurance Trust, Generation Skipping Trust, etc.) to achieve your purpose for the trust.
All trusts have three key roles. The settlor or grantor establishes the trust. The trustee manages the trust. And the beneficiary benefits from the trust. Different people can fill each role, or at times, one person can have all three.
Lastly, trusts should also contain trust property (i.e., the property contained in the trust) and the trust should be governed by certain rules outlined in the trust agreement. A word of caution here: assets you want protected by the trust must be titled to the trust. If not, it will still be considered a personal asset and have to go through probate (more on this later).
Two basic types of trusts exist: living trusts and testamentary trusts. A living trust or an “inter-vivos” trust is established during a person’s lifetime, while a testamentary trust comes into existence via a will after a person’s death. Additionally, living trusts can be either revocable, where you retain control of the assets and terms of the trust, or irrevocable, when you no longer have the assets and can only change the terms of the trust with a beneficiary’s consent.
Why You Don’t Need a Trust
Now that we’ve gotten some of the vocabulary out of the way, we can explore the advantages of a trust.
The main advantage that you will hear people tout is the ability to bypass the time and cost of probate. Probate is the process of administering a deceased person’s estate and usually involves filing fees, publication fees, document fees, attorney and executor fees, as well other court costs and fees. The process can easily costs thousands of dollars and can take several months to resolve. By contrast, the average cost of creating a trust is $1,500 to $4,000. Obviously, the more complicated the trust, the more costly.
However, many assets already avoid probate by their very nature. Property owned jointly with the right of survivorship, retirement accounts with a designated beneficiary, or even payable up death accounts like a checking account are transferred easily and quickly after death.. In addition, some states even streamline the probate process for “small estates.” You can check out those rules for each state here.
Lastly, if you’re married and you and your spouse plan to leave the bulk of your estate to one another (and you’ve likely already purchase those assets together), you also don’t have to worry about probate for the majority of your assets.Yet another advantage of marriage that all couples can now take advantage of.
With all of these workarounds and estate taxes being excluded for estates smaller than $5,450,000 for 2016, the majority of younger people with minimal assets and a valid will won’t need a trust.
When You Might Consider a Trust
Even given the considerations above, you may find yourself as a younger person that needs a trust.
First and foremost, if you think your estate might have to be probated (maybe you have more than the federal and state exemption amounts), then the costs of probate itself will likely outweigh the costs of a trust, let alone save your heirs the time, stress, and grief of having to deal with the probate process.
Other scenarios where a trust might be beneficial:
- You Own a Business – Probate may prevent your business from operating or it might have to be sold to create cash for your estate. That risk might push you to create a trust at a younger age.
- You Own Property in Multiple States: If you have property in another state (or another country), you will have to go through each state’s probate process. Again, setting up a trust for those pieces of property avoids the hassle and expense of going through that process.
- You Want to Keep Your Financial Life Private: Probate is a public process. So in order to avoid any public or family scrutiny over the division of your assets, you may want to create a trust.
- You Have a Dependent that Can’t Manage Assets Him- or Herself: If you have a special needs child or family member that you wish to care for after your death, you may arrange for the management of their support through a trust. Providing an inheritance directly to them may disqualify them from some government support.
- You Have a lot of Beneficiaries: If your have multiple people or charities that you plan to give money to at your death, it’s likely worth your while to spell out the specifics in a trust.
Deciding whether you need a trust as a part of your initial estate plan boils down to a balancing test of costs and hassle. No matter what decision you make, you will need to review whether your need for a trust changes as your financial situation grows.