Estate planning is all about deciding who gets what when you die. It helps you enjoy your wealth while still alive as well as providing the maximum benefit for the beneficiaries once you pass on. You can use trusts and wills for estate planning. But while they both have a role during your estate planning process, they work differently. For that reason, you need to understand what they are, how they work, their differences, and when to implement either option.
What are Trusts?
A trust is a fiduciary relationship where you permit one person to hold titles to properties while obligating them to use or keep them for other people’s benefit. In such legal arrangements, you, as the grantor or creator of the trust, will give a representative or trustee the right to hold asset titles on behalf of beneficiaries.
Living trusts enable you to maintain control of your assets until you die or become incapacitated. And you can change your mind about it at any time, which is why they are known as revocable trusts. However, if you create an irrevocable trust, you lose control of the assets and may only reverse it with approval from the beneficiaries.
You could also opt for a testamentary trust. The trust is created based on your last will to distribute assets after your death.
What is a Will?
A will is a document expressing your wishes concerning how you want your assets to be distributed upon your death. You can include instructions on various types of assets and how they will be distributed. These include your property, stock market investments, jewelry, cash, and other assets.
It also specifies your beneficiaries and how they’ll benefit from the distributed assets. If you don’t change your will before dying, it becomes the final document that expresses your wishes.
The Differences Between a Trust Fund and a Will
Several differences exist between a trust fund and a will. While trusts can appear in wills, wills cannot appear in trusts. Trusts and wills also don’t become effective in the same way. In addition, they provide varying levels of protection against taxation.
It’s also worth noting that wills don’t protect beneficiaries with disabilities while some trusts do.
How Wills and Trusts Take Effect
A will can only take effect when you die. So, you get to keep control of your assets until you are no longer here. And then, your beneficiaries will begin to benefit from the assets you have left to them.
However, the will is inactive until probate occurs. The probate process involves the courts determining the validity of your will and ensuring there is an executor to supervise its implementation.
On the other hand, while living trusts enable you to control your assets until your death, they don’t take effect in the same manner. Unlike wills, living trusts don’t have to undergo the probate process. Once you die, the trustee you appointed is responsible for ensuring that the beneficiaries get their property as soon as possible. As a result, there is no wait time involved.
It is also worth noting that irrevocable trusts bypass the probate process since their assets are no longer under the trust grantor’s control. Also, your beneficiaries can begin benefiting from the trust long before you die.
Your last will is a permanent document. The wishes you express in it are final, provided you don’t make changes while you are still alive. However, the same cannot be said of all trust funds.
A trust can be permanent or temporary. You can create a trust fund to last the duration of your life or your beneficiary’s life. For example, if you have a child with a life-threatening condition, such as motor neuron disease, you could create a trust to provide financial support for your loved one until their death.
However, if you create an irrevocable trust, it could be permanent like the will unless your beneficiaries let you change its terms.
Assets in your will are subject to local and federal estate and inheritance taxes. Federal tax thresholds can change, but they currently apply to property valued at over $12.06 million. However, your beneficiaries are responsible for paying the taxes on your assets when they inherit them.
Remember, you must pay taxes for a living trust while alive but not for an irrevocable trust. In the latter case, the trust pays its own taxes, and the beneficiaries pay tax on any distributions from it. You as the grantor are free from the tax burdens associated with its assets. Also, upon your death, and depending on state laws, an irrevocable trust may not be considered as part of your estate, thus escaping taxation.
In addition, gifts to trusts are not taxable as long as they remain below the annual gift tax limits, which can change based on Federal tax laws. And charitable trusts are tax-exempt if there are no non-charitable beneficiaries.
However, when beneficiaries receive income from the trust fund, they must pay their fair share of taxes after the trust takes a deduction for those distributions.
Special-Needs Government Benefits
Many people with special needs are eligible for needs-based government benefits. However, some of those benefits may disappear if they receive more financial resources than were initially claimed.
Wills can’t protect benefit recipients from the consequences of inheritance. This means they may lose their benefits due to the additional income because the government will consider it a financial resource. However, a special needs trust can get around that problem.
Special needs trusts are vehicles that allow a beneficiary to enjoy additional income without jeopardizing their needs-based benefits, such as SSI and Medicaid benefits.
The trustee will control the trust fund and determine how its assets are distributed on behalf of the intended beneficiary. However, since the beneficiary won’t have any control over the trust, the government cannot consider it when determining benefits.
When Would a Trust Fund Be a Better Option vs. a Will?
When considering the differences between irrevocable or living trust vs. a will, you need to weigh the pros and cons of each. Then you can decide which vehicle to use for estate planning. Remember, you can use both if you prefer.
Wills are excellent tools for naming executors and determining who will have a say over your loved one’s welfare. Also, they work well for giving instructions about your funeral, burial, and other decisions that can only be made after you die.
On the other hand, trusts are excellent vehicles for skipping probate, reducing your tax burden, and protecting your beneficiaries from excessive taxation upon your death. In addition, they can safeguard the interest of your loved ones with special needs without compromising their benefits.