There’s one question I hear a lot at the beginning of the legacy planning process: “Should I use a will or a trust as part of my plan?” Some might go as far as debating between the two, but I feel that this is actually a false dichotomy. Here’s why: both wills and trusts can be used as estate planning resources for effectively transferring assets, but asset transfer is only one component of a thoughtful estate plan.
There are some major differences between wills and trusts, as well as how they can be used. Trusts have strengths and benefits that wills do not have, but the inverse is also true. I believe that for most families, the most effective plans utilize both! Let’s start from the beginning:
What is a Will?
A will is a legal document that outlines your wishes in relation to how your estate will be handled after you die. This includes things like assets, debts, personal property, real estate…basically everything you owe or own. You can outline where you would like those assets to go in your will. However, there are other components of a will that are not related to assets:
A Will Covers Funeral/Memorial Directives.
A common component of a will is directions to your loved ones as to how you would like your funeral or memorial service to be handled. This can include preferences for your remains and location of the service as well as important components of the service itself. The cost of the service is commonly covered by the estate of the individual who passed.
A Will Covers Disinheritance.
While most individuals plan to transfer the bulk of their estate to their heirs, there can be times—like estrangement or divorce—when it is necessary to exclude someone from the estate. Although that can be a difficult decision to make, the process itself isn’t difficult. Just make sure that you have an attorney work with you on the wording of your will to ensure your wishes are going to hold up in probate.
A Will Grants Guardianship of Minor Children (and Pets!)
This is one of the most important parts of a will for those with minor-aged children at home. If guardians are not named, the state will do their best to place the children, but a court may not select the person you would have wanted. They also would not consider family friends as guardians, even if they were better-suited than family members to be caretakers. Only family members are considered by the state to act in a guardian role. The same is also true for pets that you own.
Without guardians named in a will, guardianship gets handled through the probate process, which involves the state, lawyers, and potentially extra costs and fees. To learn more about the probate process and why a comprehensive will is important, check out our blog post on what happens when you die without a will.
What is a Trust?
A trust is a fiduciary arrangement that allows a third party (trustee) to hold assets on behalf of beneficiaries. Trusts are traditionally used for minimizing estate taxes, but can offer other benefits as part of an intentional estate planning process. They can come in all shapes and sizes. They can be set up during life, as a “living trust,” or through a will when someone dies, called a “testamentary trust.” In the case of a testamentary trust, the successor trustee would then distribute the assets of the trust according to the rules laid out in the trust document. The trust is activated when the grantor (the person who funds the trust) signs it. Once assets have been titled in the name of the trust, they should no longer have to go through the probate process at the death of the grantor.
In the traditional debate of “will” vs. “trust,” what people often mean to ask is, “speaking only in terms of transferring assets, would it be better to direct those assets through a will or through a revocable living trust?” That question might be clearer, but the answer depends on what you are trying to achieve and what types of assets you have. (Confused yet? Hang in there.)
Trusts are wonderful for specifically transferring assets, but that is all they are designed to do. Here are a few benefits to having a trust, though:
A Trust is Private, and Avoids Probate.
The two largest reasons for utilizing a trust is for privacy and for assets passing outside of probate. Since the trust beneficiaries are determined prior to the death of an individual, there is no need for further decisions by a personal representative or estate executor. And since the assets are passing outside of the probate process, there is no public record of the transfer (as there would be with any assets transferred via will).
A Trust Can be Revocable or Irrevocable.
The format of the trust itself can also create other benefits in the estate planning process. A revocable trust is used when a person transfers property into a trust and retains the right to income from or use of the property. For estate planning purposes the property must be included in the transferor’s estate. Since the grantor can be the trustee and direct assets, this is called “incidence of ownership,” meaning you have control over the assets, and as such, they will be included in your estate.
You have a lot of flexibility with a living trust, with freedom to modify or revoke it if you feel that it is no longer necessary. One of the most common uses of a trust is called the “Living Trust” which is a revocable trust and is a common alternative to wills as it relates to directing assets. When you set up a revocable living trust you will also need to have a “pour-over will”. The pour-over will is like a safety-net. The will directs the Personal Representative that any assets that have not been titled in the name of the living trust should now title them in the name of the trust and distribute them according to what is outlined in the trust. These assets directed by the will, will need to go through the probate process.
Irrevocable trusts are commonly used to remove the value of assets from a person’s estate, which may reduce the amount subject to tax. When you give to a trust irrevocably, you no longer have control over the trust. Since you are basically giving assets away forever, the value can no longer be counted toward your estate.
With an irrevocable trust, the trust cannot be changed after the grantor signs it (with some rare exceptions). Additionally, the grantor cannot be a trustee or manage the trust, otherwise there may be “incidence of ownership.”
There Are Other Types of Trusts.
Trusts such as Irrevocable Life Insurance Trusts (ILIT) or Charitable Trusts can also be great ways to draw out inheritance for your heirs over several years, and also provide for charities you care about. ILITs utilize life insurance as part of an intentional estate plan, where Charitable Trusts are a great way to utilize pre-tax assets from your estate to be invested for growth, benefit heirs, and also make a significant gift to charity…all while saving on tax.
I haven’t even gotten to Asset Protection Trusts, Constructive Trusts, Special Needs Trusts, Spendthrift Trusts, and the list goes on and on…but that’s information for another post!
So…Should You Have a Will or a Trust?
In conclusion, we’ve established that there’s a place for both wills and trusts. Depending on your situation, many experts will recommend that you use both. While trusts have the advantage when it comes to transferring assets, they don’t allow you to outline your wishes for the non-asset components of your estate. And when it comes to minor children, guardianship is only something that can be outlined in a will.
Former Legacy Consultant
Ryan joined our team from the marketing and advertising world, where he learned that effective communication leads to action. Though he left the Apex team in our business transition this past summer, he left this blog post behind, and we’re posting it with his permission. Ryan’s interest in personal finance–paired with a passion for stewardship–made gift planning an ideal career path for him, and he’s building on that work today. We wish him all the best in his next endeavor!