One of the first questions clients often ask me is, what is the difference between a will and a trust, and why should I want one or the other? There are five key things a will can’t do – avoid the expense of probate, immediately transfer your assets to your heirs, protect you and your heir’s privacy, avoid estate taxes, and provide incapacity protection. But a complete estate plan with a living trust can handle all of these things.
A Will Does Not Shield Your Heirs from the Expense of Probate
This often comes as a surprise to many people, but it’s true – wills do not avoid probate. If the gross value of your estate is over $150,000 in California, your heirs will have to go through the entire slow, expensive and public process of probate even if you have a will. And probate is expensive. Even a modest estate of $200,000 would incur $14,000 in attorney and executor fees.
A Will Won’t Immediately Transfer Your Assets to Your Heirs
While it is theoretically possible to conclude a probate matter in about 6 months, most estates take even longer. What this means is that your beneficiaries may need the money from the estate but they won’t have access to their inheritance until after the court is satisfied that all creditors have been notified, and the estate is in a position to be closed, and the assets distributed. A trust puts the successor trustee immediately in charge.
A Will Won’t Protect You or Your Heirs’ Privacy
Probate is a public court proceeding. One of the required documents for a probate case is a complete inventory detailing all of the assets, and all of the expenses and all of the income during the time of the probate case. The order for distributing all of the assets details exactly who gets what. In today’s world of identity theft, this information is a treasure trove from a scammers perspective.
A Will Can’t Protect Your Estate from Estate Taxes
Estate tax planning for high net worth individuals involves a number of different legal strategies, but none of them involve creating a simple will. The reason is that a will deals with what is in your estate, and in order to deal with estate taxes, we look at ways to move assets out of your estate.
A Will Provides No Incapacity or Disability Protection
A will only takes effect at a person’s death. But if you are unable to make medical or financial decisions, who will be able to make those decisions on your behalf? An executor under a will won’t be able to help you.
The One thing Only a Will Can Do
In California, the one thing a will can do, but a trust can’t, is nominate a guardian for your minor children. That is one reason why all of our estate plans that include a living trust also include a will. A will is always included as a backup document to a living trust.
An estate plan gives you lots of opportunities to define when and how your beneficiaries can use their inheritance. Inheritance is a nice word for everything you’ve worked hard for all these years. Maybe you want to specify that your children can only invest in tax free bonds, and can never use your money for a vacation ever, or maybe you don’t. Either way, your estate plan can provide some pretty amazing legal protection for your beneficiaries without controlling their lives.
The “Old Way” of Trust Planning
Traditionally, trusts survived just long enough to avoid probate for Mom and Dad’s estate, and divide everything between the children. At the end, the children now own everything directly, which sounds great. Unfortunately, this exposes your hard earned money to your children’s creditors, lawsuits, and potentially, even divorcing spouses.
The “New” Better Way
Instead of giving your children their inheritance outright, each beneficiary may instead receive their inheritance inside a special trust created by your own personal Living Trust. This trust gives your child the benefits of ownership without the legal liability of ownership. It’s like giving your children their inheritance inside an LLC without the expense and complication of the corporate overhead.
How it Works
Let’s say Doctor Lenny inherits a home and some cash from his parents who had an “old” trust. On his way to work the car in front of him stops suddenly causing Lenny to crash into the back end of a bright red Italian sports car. Months later, and several attorneys later, Doctor Lenny hands over what is left of his assets to settle the lawsuit – his own assets and his inheritance, gone.
If we rewind and give Doctor Lenny his inheritance in a “new” trust, his parent’s home and cash are now held in his own separate trust. Same car crash, same lawsuit, and Doctor Lenny is handing over what is left of his assets – except the inheritance. His parent’s house and cash are left untouched.
Who it’s For
If you would like your beneficiaries to think of their inheritance as capital to be wisely managed and invested, this type of trust is for you.
Please note: any trust strategy alone does not guarantee “bulletproof” asset protection. But it does offer dramatically increased protection over holding assets outright. Before proceeding with any estate planning, you should consult with a qualified attorney.
Besides Top Ramen, there are two essential legal documents your high school graduate needs to have in place.
Two Key Legal Documents
It may be hard to believe your child heading off to college really is an adult, but they’ve officially crossed that threshold into adulthood. It’s an exciting time. And it’s a very legally vulnerable time because now your child does not have a default backup for important medical and financial decisions the way you and your spouse do. Even between spouses though, I think every adult should have these two key legal documents.
Your child’s medical information is legally protected, and it may be difficult or even illegal for medical providers to share information with you in case something happens to your child. When congress passed The Health Insurance Portability and Accountability Act in 1996 (HIPAA) one of their goals was to protect patient privacy. Because the penalties for violating the rule can be steep, doctors and hospital administrators are very cautious when releasing medical information. As a parent that can present a very frustrating and frightening situation in a hospital emergency room. Your child may not be in a position to give consent, and you don’t have time to go get a court order (an “emergency” action by the court could still take a week or more for a “temporary” order) not to mention the cost of filing fees and attorney assistance. To avoid all of that, your child (now adult) should prepare an Advance Health Care Directive to appoint the person they want to represent them if they are unable to speak for themselves.
The second document is called a Durable Power of Attorney, and it gives the appointed agent the ability to handle all financial matters. While most college age children don’t have a lot to manage, the Power of Attorney can be a good safeguard against a potentially devastating impact of an event that leaves them incapacitated. Imagine a car accident has left your child incapacitated – can you step in and handle all the important legal and financial matters that will ensue?
It can save you thousands by avoiding the need to obtain a conservatorship of the estate. You may think, well, my child just has a small bank account, what is the big deal? The big deal is everything that is not in a bank account: handling insurance claims, lawsuits, lawyers, lenders, and the IRS. Your bank paperwork won’t help with any of those people – you’ll need a conservatorship or a power of attorney to act on your child’s behalf.
So, in between all the notebooks and highlighters, slip two important legal documents. Welcome to the adult world, kid.
One of the questions I get all the time is, should I put _________ (name an asset) into my trust? The answer, of course, is that it depends on the asset, but generally speaking, everything you own should be transferred to the trust. Which leads to the follow-up question: do I lose control of my assets when I put them into my trust?
Why Put Your Assets Into A Trust
If your goal is to avoid probate and you’ve created a trust to accomplish that goal, you need to understand one thing. Assets owned by the trust avoid probate. Assets not owned by the trust are exposed to probate.
Now that you understand the importance of your trust owning your assets, who controls your assets?
Who Is In Charge of My Trust?
When you create your trust, naturally you put yourself in charge of your trust. And you also chose who will be in charge after you, and maybe even who will be in charge after that person. The person in charge of the trust and the assets inside the trust is called the Trustee. When you created the trust, you made the decision about who the successor trustee will be and when they step into your shoes as trustee. Though who the trustee is will change as time goes by, you made the decisions when you created the trust.
Who Gets to Benefit From My Trust?
While you’re alive, you’re the beneficiary of your trust, and after your gone, your surviving spouse is typically the sole beneficiary of the trust. After you and your spouse are gone, then you get to spell out in your trust exactly who gets your estate, when they get it, and under what circumstances.
It’s Your Trust
As the creators of the trust, you are completely in charge of what goes into, and what comes out of your trust. And because it’s a revocable trust, you can completely change the trust itself, including getting rid of it completely should you so choose. It’s all up to you.
A trust gives you the ability to spell out exactly who gets what and when. Now that is total control over your assets!
Not all living trusts are the same. And I’m not talking about quality either, though that is a major factor too. I’m talking about the difference between minivans, pickups, and sports cars. There are five major types of trusts that we use every day in our practice for different situations.
Probate Avoidance Trust
This is the basic, direct distribution trust that is the typical trust people are introduced to when they learn about wills vs. trusts. This trust takes a no-nonsense, keep-it-simple approach to dividing all the assets between the beneficiaries and having accomplished its purpose, ride off heroically into the sunset.
Personal Asset Trust
What if your beneficiaries’ inheritance could be protected against lawsuits, creditors, and even divorcing spouses? With Estate Plan Pros’ “Personal Asset Trust” you can provide dramatically increased protection for your beneficiaries against these financial risks. Read more about the Personal Asset Trust here.
Surviving Spouse Asset Protection Option
If you have children from another relationship that you’re including as beneficiaries, what happens when you’re not the surviving spouse? What happens to your assets? We can set up the trust to split in half at the death of the first spouse so that portion becomes an asset protection trust, and locks in the beneficiaries for your half of the estate.
Beneficiary Protection Trust
Some beneficiaries should not control their inheritance, or at the very least need some assistance managing their inheritance. A beneficiary might have significant disabilities that qualify them for government assisted programs like SSI, SSDI, Medi-Cal, or might have significant substance abuse issues, or event simply major financial problems. For these beneficiaries a Special Needs Trust or Spendthrift Trust can be set up to manage the inheritance for the beneficiary’s lifetime. This allows the beneficiary to receive the benefits of the inheritance without the burden or responsibility of managing the funds.
Retirement assets such as IRA’s, 401k’s and all their variations can often be the most significant asset that will be passed on to the next generation. Yet without prudent planning beneficiaries can accidentally or intentionally destroy the stretch-out of the inherited retirement plan. Additionally, the recent U.S. Supreme Court case, Clark vs Rameker, held that any asset protection you enjoy for your own retirement plan does not pass on to your beneficiaries. The Stand Alone Retirement Trust addresses both of these problems by helping ensure a proper rollover of the asset and giving your beneficiaries the option of using the retirement account as a protected asset. You can read more about the Stand Alone Retirement Trust here.
Every family is different, and their estate plan is going to reflect those differences of personalities and needs of beneficiaries. While these five broad categories describe the most common options, there other strategies and options that your estate planning attorney can review with you.
If you have the wrong kind of trust, naming it as the beneficiary of your retirement account could cost your kids a lot in extra taxes. How? It happened because you’ve just forced your heirs to report the entire amount as income.
When you inherit a retirement account, several things change immediately. The first is that the account will look at the new owner to re-calculate the measuring life on the account. If they can see a person, they’ll use that person’s age. This is called the “stretch out rule”. But, if they just see an entity like most trusts that have no age, there is no stretch out, and the beneficiary will be forced to close out the IRA account and take the income tax hit. If you have an ordinary trust, naming it as the beneficiary kills the possibility of a stretch-out.
The second big change when you inherit a retirement account is that there is no longer any early access penalty. You could withdraw the entire amount, or something less, and the only consequence is that you will owe income tax on the distribution. This is why the US Supreme Court in Clark v. Ramiker decided that creditor protection laws do not protect inherited retirement accounts.
What about the right kind of trust?
The right kind of trust is specifically designed to handle retirement accounts, and meet the four requirements of a see-through trust outlined by the IRS. A retirement trust allows you to preserve the stretch out for your beneficiaries, and put into place the plan and asset protection a trust can create.
Using this kind of trust, you can:
- Help keep the IRA in the family, by avoiding having a child name his or her spouse as a beneficiary, and seeing the money go to that new spouse’s children
- Protect the asset in case of a divorce
- Manage the account for beneficiaries who are young children, elderly or disabled
- Give direction and security for a beneficiary with poor money management skills
Unless you have the right kind of trust, don’t send your retirement funds there. But do consider the benefits to your children of using the right kind of trust for your retirement funds.