One key component of financial planning is leaving a legacy, which includes ensuring assets are smoothly transferred to heirs upon your death and/or mental incapacitation. Various tools can help you accomplish this, two of which we’ll review here today: wills and trusts.
An overview of wills
A will—also known as a last will and testament (or testamentary will)—is simply a legal document that ensures an estate is settled in the manner the deceased had intended. More specifically, the document communicates your final wishes concerning how assets and other possessions are distributed following your death.
A common misconception is that estate planning is just for the elderly or wealthy. The fact is, however, that if you own a bank account, car, home, furniture, or an insurance policy, you have assets. As a result, however modest your estate is, you’ll need to establish a plan for how they are distributed upon your death.
An overview of trusts
A trust—another method used to transfer assets after you pass away—dictates you appoint a trustee to manage and distribute your assets to beneficiaries. Like wills, trusts aren’t just for the wealthy and are created for various reasons we’ll discuss shortly. While many types of trusts exist, all fall within two categories: living and testamentary.
Living trusts are available as either revocable or irrevocable options. A revocable living trust is created while the trustor is still alive and can be adjusted during his or her lifetime given ongoing ownership of property or assets. On the other hand, an irrevocable living trust is not easily changed as trustors relinquish control of assets to the trust itself: which in turn seizes ownership. With either option, the trust goes into effect the day you sign it.
Meanwhile, a testamentary trust—also known as a “will trust” or “trust under will”—is created by your estate executor with your last will and testament. The trust doesn’t go into effect until the will is probated and the executor settles the estate, actions which don’t occur until after the trustor’s death.
Key differences between a will and trust
Wills and trusts are both estate planning tools designed to ensure assets are protected and transferred to heirs per your wishes. However, one of the biggest differences between each option is probate: wherein a court verifies that your will is indeed valid and authentic.
Wills are required to pass through probate, but keep in mind that if you possess a will at the time of your death, the probate process is far more streamlined than it is in the absence of the same (referred to as “dying intestate”). Alternatively, living trusts don’t require your assets to go through probate: potentially saving your heirs time and money.
Another key difference is that wills can be contested in court whereas trusts generally cannot. The former document type is often contested when an individual (family member, friend, business partner, etc.) believes he or she was wrongly disinherited or a beneficiary doesn’t agree to his or her share of the estate. That said, the person contesting must have legal standing to file a lawsuit: either claiming the testator (owner of the will) wasn’t mentally competent, laws were broken during the writing of the will, or a more recent version of the will is available. A trust, meanwhile, can help avoid potential headaches that arise when a will is contested.
With a revocable living trust, you can name a trustee to take authority over your assets and thus protect your estate should you become incapacitated and unable to manage your affairs. This is not possible with a will unless you accompany the same with a durable power of attorney (a legal document that gives the party of your choosing the power to make legal decisions on your behalf when and if you ever become incapacitated or can’t act on your behalf).
If you’re concerned about keeping your estate affairs private, a living trust is beneficial as it won’t become a public document after your death (unlike a will).
Furthermore, a living trust can also continue to operate after your passing since you can direct your trustee to hold assets until a beneficiary reaches a specific age or attains a certain milestone or life-changing event (such as getting married). Conversely, your assets are typically distributed soon after your death if you have a will.
A final differentiating point is the associated price tag. While you can easily create a basic will for under a few hundred dollars, trusts often cost at least $1,000 if you decide to enlist the help of an estate planning attorney.
When to choose a will or trust
A will is often recommended in this case as it allows people to better control how assets are distributed to heirs upon their death. If you don’t have many assets, aren’t married, and/or plan on leaving everything to your spouse, a will is perhaps all you need.
On the other hand, a good rule of thumb is to consider a revocable living trust if your net worth is at least $100,000. Even so, be sure to check your state’s “small estate” laws—which set dollar amounts or caps for a decedent’s estate—knowing that anything below these thresholds may allow you to bypass probate.
Additional reasons to consider a living revocable trust involve implications of leaving assets to minor children (generally under the age of 18, but the exact number varies by state) and to better protect your children’s inheritance from a divorce.
A will is often beneficial for leaving an inheritance to minor children as the process can ensure you choose the best legal guardian while also naming a custodian responsible for managing assets that benefit your children. However, once your child is no longer a minor, he or she will generally receive this inheritance in one lump sum.
In this scenario, a trust provides additional flexibility as you can spell out specific requirements that must be met for your children to receive their money (e.g., the age at which they can receive portions of their inheritance or an event dictating the same, such as college graduation).
A trust is also an ideal way to protect your child’s inheritance from a divorce. For example, inherited money or property is typically considered separate property and not divided in a divorce unless it becomes “commingled”: meaning the inheritance is placed in a joint bank account used by both husband and wife or if both spouses invest in an inherited property. A trust can ensure inherited assets never become marital property.
While we won’t dive into all related details here for the purpose of brevity, one typically only creates an irrevocable trust to decrease the value of an estate, qualify for Medicaid or similar income-restricted programs, and/or minimize estate taxes.
Choose a will or trust—or both!
It’s also helpful to know that having a trust shouldn’t preclude you from creating a will: as a will does things a trust cannot, such as naming a guardian for minor children. A living trust also never includes all of your assets. For example, it’s often recommended to not include qualified retirement accounts (e.g., 401k or IRA funds) in a trust account since such an activity is considered a complete withdrawal of those funds—subjecting you to tax.
In sum: final thoughts about wills and trusts
Which is better: a will or trust? The answer will always depend on your own personal situation. Almost everyone should have a will, but if your net worth is greater than $100,000, you have minor children, and you want to spare your heirs the hassle of probate and/or keep estate details private, consider adding a trust a mix. Either way, consider seeking guidance from a professional—such as a financial advisor—who can help guide you through the process.
Still wondering whether a will or trust is right for you? Schedule a FREE Discovery call with one of our CFP® professionals.
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Vision Retirement is an independent registered advisor (RIA) firm headquartered in Ridgewood, New Jersey. Launched in 2006 to better help people prepare for retirement and feel more confident in their decision-making, our firm’s mission is to provide clients with clarity and guidance so they can enjoy a comfortable and stress-free retirement. To schedule a no-obligation consultation with one of our financial advisors, please click here.
Disclosures:
This document is a summary only and is not intended to provide specific advice or recommendations for any individual or business.
