Do I Need a Trust? Part 1: Types, Benefits and Drawbacks
By David Wise
At Hilltop, one of the discussions we have every year with our planning clients is about the essentials of estate planning: a last will and testament, powers of attorney, etc. These documents will cover the basic needs for most people.
But what about a trust? Is the extra cost and trouble of a trust really worth it? As with so many other questions, it depends on your circumstances and goals. There are a number of types of trusts designed to meet different needs, whether you’re looking to preserve wealth for future generations, protect your heirs from themselves or harmful situations, or simply avoid the legal hassles of the probate process.
But to know whether this may be right for your estate plan, it’s important to first understand how a trust works. Simply put, a trust is a relationship in which one party gives another party, the trustee, the right to hold property or assets for the benefit of a certain person, the beneficiary. There are several main categories of trust type: revocable, irrevocable and testamentary.
Revocable Trust
A revocable trust is primarily designed to allow you to keep control of assets. In fact, you can still change the document as long as you’re alive, hence the name.
For example, let’s say I have a beach house that I wish to keep in my family for generations, but obviously I still want to use it now. I could place the beach house in trust and name myself as trustee to ensure the beneficiaries keep the house in the family for future generations. Meanwhile, my family and I can fully enjoy the house in the present. During my lifetime, I can revoke the trust or sell the house at any time. But at my death, the trust becomes irrevocable, and my beneficiaries must legally follow the rules. With that said, you should think carefully about your family dynamic before adopting this strategy; you can imagine the strife that could arise for a family with varying goals and financial means trying to maintain an older generation’s beach house.
An even more common situation for a revocable trust is to simply use it to hold non-retirement assets, including your bank and brokerage accounts, vehicles and home. With the revocable trust, you can retain control of these assets during your lifetime while simplifying the management of your estate when you die.
Irrevocable Trust
In contrast to a revocable trust, an irrevocable trust you give up some rights to control the assets transferred to the trust and you may even give up your right to adjust the trust document during your lifetime. Irrevocable trusts are commonly used to: avoid estate taxation, protect assets from creditors, ensure children in blended families do not get disinherited while providing adequate income to a surviving spouse, and help families provide a charitable legacy while enjoying consistent income.
Testamentary Trust
Both revocable and irrevocable trusts are created “inter vivos,” or during one’s lifetime. However, the law also permits you to use your last will and testament to create something called a testamentary trust. This type of trust would be created at your death and would be funded with any assets you designate in your will. A common example of this is a “minor’s trust”, which is created to allow a minor child to inherit mom and dad’s estate – until the child reaches adulthood, a trustee will manage the funds for that child’s benefit.
Just as there are many types of trusts, there are also a number of potential benefits. Some of the more common benefits include:
Control - You may be worried that your heir is not ready to manage the wealth you’ve worked so hard to build. A properly designed trust can allow you to leave your estate to your heirs and limit access to the assets until a certain age or require that the money be used only for certain types of expenses.
Probate relief - Probate is the legal process that takes place after someone dies. This process can delay the distribution of your assets to your heirs, not to mention give your executor a big headache. Take a minute to read my earlier post “What I Learned From My Grandfather After His Death” for more on this.
Privacy – You may not realize that when you die your last will and testament may become public record for anyone to read. Scary thought, right? By keeping your estate out of probate, a well designed trust can keep your estate away from prying eyes.
Creditor Protection – You may be wondering, “How do I protect my legacy from creditors?” A trust can help do that as well. If set up properly, a trust can help shelter your estate from creditors before and after death.
Protection from estate taxes – There are trust structures that can allow you to legally minimize estate taxes at your death. Trusts for this purpose have become less common as the amount excluded from estate taxes has risen dramatically over the last decade. But if you have a sizeable estate, these strategies can save your heirs a lot of money.
However, there are also potential drawbacks to creating a trust, including some of the following:
Extra cost - As you can imagine, adding a trust to your estate plan increases your out-of-pocket expense. The more time an attorney spends on the documents and the more elaborate the language used, the higher the price tag you can expect.
Added restrictions - Particularly with irrevocable trusts, the conditions of the trust can be set in stone after execution, so make sure to ask yourself “Would I draft this same document five or ten years from now?”
Complexity – This area of law is highly specialized and constantly changing. Therefore, your estate and trust planning should be overseen by an attorney who has a core focus in estate and elder law.
The need for regular review – Life changes, and so should your estate documents. As you go through different seasons of life, make sure you review your documents periodically and update them as necessary. This becomes especially important when you experience a major life event such as a new baby, divorce, death of a close family member, etc.
Understanding the basic types and benefits of a trust can help you ask better questions when you work with your estate attorney. But you may also be interested in some specific scenarios where a trust could be appropriate and ideas on how to properly use one. Watch the Hilltop Views blog for a follow-up post exploring these aspects in more detail.
Disclaimers
Hilltop Wealth Advisors does not provide legal advice. This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.
The information contained herein is believed to be true as of the date of publication. It may be rendered out of date by subsequent legal or tax-rule changes, as well as variable economic and market conditions.