In my last blog entry, I talked about common mistakes when making our estate plans. My number one mistake was failing to make an estate plan at all. Our failures to plan for the future may have to do with a lack of understanding of what’s available. I’ve long held the notion that the more we understand something, the less daunting or scary the thing appears.
Because of this, I want to go a little more in depth about some of the estate plans, or “instruments,” available to us when planning our futures. If our estate plans are enacted through instruments, we are the conductors using those instruments to create a unified sound. Our plan.
This information is meant to be a general guide and show the importance of clear communication between you, your attorney, and your loved ones. Your attorney should have an understanding of the entirety of your estate, but just as important, a clear picture of your goals that guide you in deciding the proper estate-planning instrument.
What is an “Estate?”
An "estate" refers to everything an individual owns, including but not limited to their home, investments, bank accounts, personal property, and real estate. Essentially, an estate is everything that an individual has accumulated during their lifetime that they want to pass on to their loved ones after their death. Proper estate planning can help ensure that an individual's estate is distributed according to their wishes, that their family is taken care of after their death, and that their estate is protected from unnecessary taxes and probate costs.
What happens if I die without an instrument?
When an individual passes away without an instrument, their assets become subject to intestacy laws. These laws outline how the assets will be distributed, typically to the closest living relatives, such as a spouse, children, parents, or siblings. In the absence of surviving family, the state may acquire the assets. Intestacy laws may not align with the individual's desires and can cause delays, added expenses in estate administration, and increase the likelihood of family conflict. It’s practical for individuals to have a will or trust in place to ensure their assets are distributed according to their wishes and to avoid any legal entanglements.
Think of it this way: if you die without an instrument, you’re leaving the government to play your last song.
… Exactly.
Last Wills and Testaments, in General
A last will and testament is a legal document that outlines an individual's wishes for how their assets will be distributed after their death. It is a relatively simple and affordable document to create, but it must go through probate court to be executed. Probate court is a legal process that ensures the will is valid and the assets are distributed according to the person's wishes.
After the individual's death, their last will and testament will be submitted to probate court, where a judge will oversee the distribution of their assets. A last will and testament is a useful instrument for distributing assets in a straightforward manner and can be a good option for individuals with relatively simple estates and straightforward distribution wishes.
Let's take the example of John and Judith, a married couple in their 50’s with an estate worth $500,000, including a house, two cars, and a few investments. John wants to distribute his assets to his wife if he were to pass before her, then equally between his two children in the event he outlives his wife. Judith wants the same. A last will and testament would be an excellent estate-planning instrument as it is affordable and can adequately distribute their assets.
There are some drawbacks to keep in mind, though. The probate process can sometimes be drawn-out and costly. Court fees and legal expenses can eat into the value of the estate. For example, a family member can contest the will, or there can be discrepancies in the assets being distributed, like a missing car title or a recording error in a deed. Additionally, because the probate process is a matter of public record, an individual's financial affairs become public knowledge, which can be undesirable for some individuals.
Trusts, in General
A trust, on the other hand, is a legal entity that holds assets for the benefit of one or more individuals. While a last will and testament is subject to probate, a trust can help individuals avoid the probate process.
Once the specific trust instrument is drafted, to become valid an individual, or “grantor,” must then transfer assets into the trust and name a trustee to manage the assets on behalf of the trust's beneficiaries (in many cases, the grantor can name themselves as trustee). Unlike a last will and testament, a trust is effective immediately upon creation, or “funding,” and assets held within the trust are not subject to probate. When an individual dies, the assets within the trust are distributed according to the terms outlined in the trust agreement, without the need for court intervention.
The trust document typically lists out the assets in the trust, but it is a private document that is not filed with any government agency or court during the lifetime of the grantor. Instead, it is kept in the possession of the trustee or another designated individual. When the grantor passes away, the trust document becomes relevant for the administration of the trust. It may need to be filed with a court or government agency as part of the probate process, depending on the laws of the state and the specific circumstances of the trust. However, the trust document is generally not made available to the public, unlike a will, which is typically filed with a probate court and becomes part of the public record.
Another advantage of using a trust instead of a last will and testament is the potential for tax savings. By transferring assets into a trust, individuals remove those assets from their “taxable estate,” potentially reducing their estate tax liability. Additionally, some specific types of trusts, such as irrevocable life insurance trusts, can be used to hold life insurance policies, helping individuals avoid estate tax liability on the proceeds of those policies. Overall, for individuals with significant assets or potential estate tax liability, using a trust as part of their estate plan can be an effective way to reduce tax liability and maximize the value of their estate for their beneficiaries.
A trust will generally cost more to create than a last will and testament. How much more can vary depending on the complexity of the trust, the types of assets involved, and the fees charged by the trustee or other professionals involved in the process. Individuals with more complex estates and specific wishes for how their assets will be distributed should always discuss creating a trust with their attorney, and make a decision on which instrument best suits their needs.
Much like a strings section in an orchestra, trusts also come in many different forms. Below is a deeper dive into some of the more common trusts.
Testamentary Trusts
A testamentary trust is a trust that is created through a last will and testament and comes into effect after an individual's death. It is an excellent instrument for individuals with minor children as it can help ensure the assets are distributed to them appropriately. It allows individuals to designate beneficiaries to receive assets from the trust and can provide ongoing, controlled financial support to those beneficiaries. A testamentary trust is only activated when the person creating the trust passes away, and their assets are distributed through the trustee.
A testamentary trust is created as part of an individual's last will and testament and only goes into effect after the individual has passed away. The assets are distributed to the testamentary trust according to the terms of the will, and a trustee is appointed to manage those assets on behalf of the trust's beneficiaries. An additional benefit is the flexibility to change or modify the trust's provisions during the grantor's lifetime, making it easier to adapt to changing circumstances. A testamentary trust can provide for the long-term management of assets for beneficiaries who may not be equipped to manage those assets on their own.
Testamentary trusts can be an ideal option for those who want (or need) more control over their estate in the event of an untimely death than an individual with a last will and testament. For example, if an individual wants to leave assets to a minor child or an adult who needs a controlled budget to be provided to them. Where a last will and testament is simply a transfer of assets to the beneficiary, a testamentary trust can be created to provide ongoing management and oversight of those assets. The trust agreement can specify when and how distributions should be made to beneficiaries. Finally, for individuals with significant estate tax liability, a testamentary trust can be used to help minimize the tax burden on their estate. Overall, a testamentary trust can offer greater flexibility and control over the distribution of assets, while also providing for ongoing management and oversight to ensure that beneficiaries are properly cared for.
For example Sarah, 45, is a successful business owner with an estate worth $2 million, including a home, multiple properties, and various investments. Sarah has a 16-year old son and she wants to ensure he uses her estate wisely in the event of her untimely death. Sarah also wants to ensure the other assets in her sizeable estate are distributed according to her wishes. A testamentary trust could be a good estate-planning instrument for Sarah as it can provide ongoing, responsible financial support to her son and ensure her assets are distributed according to her wishes.
Alternatively, take Jack and Jill, a young couple with good career prospects but currently have a small estate worth $200,000, including a home and two cars. Jack and Jill have two toddlers and want to ensure their assets are distributed to them appropriately if anything were to happen. A testamentary trust could be an excellent estate planning instrument for Jack and Jill as it can help ensure their children's financial needs are met if they were to pass away.
Revocable Living Trusts
As the name implies, a revocable living trust is a trust that is created in the grantor’s lifetime, but can be amended or revoked during that period. Assets transferred into the trust are managed by a trustee, who is often the individual creating the trust, and the trust agreement outlines how the assets should be distributed upon the individual's death. The assets are “held” by the entity during the individual’s lifetime, and then distributed through the successor trustee appointed by the grantor. It is similar to a last will and testament, in that it can be a straightforward document to distribute assets, but does not go through probate court and is not public record.
For example, let's bring back John and Judith, but now they have retired, saved a little more, and now have an estate worth $1.5 million, including a home, a condo, investments, and a few vehicles. John and Judith want to ensure their assets are distributed according to their wishes, avoid the probate process, and to keep their finances private. A revocable living trust would be an excellent estate-planning instrument for John as it can help accomplish both goals.
A revocable living trust is also an excellent instrument for individuals with larger estates as it can help reduce estate taxes and avoid probate court. Remember Sarah? Now her estate is worth 3 million, but her son has graduated college and she is no longer worried about his responsibility when he inherits her estate. She now wants to minimize estate taxes and avoid probate court while still ensuring her assets are distributed appropriately. A revocable living trust would be an excellent estate planning instrument for Sarah as it can accomplish all her goals.
Irrevocable Trusts
An irrevocable trust is a legal document that holds a person's assets during their lifetime and distributes them after they pass away. It is similar to a revocable living trust but cannot be changed or revoked once it is created. An irrevocable trust is an excellent instrument for individuals with a high net worth as it can help reduce estate taxes and protect assets from creditors.
Creating an irrevocable living trust may be a good option for someone who wants to protect their assets from creditors, lawsuits, or potential Medicaid eligibility issues. Unlike a revocable living trust, an irrevocable living trust cannot be modified or terminated without the consent of the beneficiaries. This means that the assets transferred to the trust are no longer considered part of the grantor's estate for tax purposes, and they are protected from any future creditors or lawsuits. However, because the trust is irrevocable, the grantor cannot change the terms of the trust once it is established. Additionally, the grantor must give up control of the assets transferred to the trust, which may not be desirable for some individuals. Overall, an irrevocable living trust can be a good option for those looking for more asset protection and tax planning than flexibility with their assets.
Let’s bring back Sarah, but now she’s 63-years-old with an estate worth $6 million, including three homes, multiple business interests, and investments. Sarah is worried about her future health and wants to reduce her estate tax liability in the event she needs round the clock medical care. An irrevocable trust would be a great instrument for Sarah as it can help shield tax liability for her beneficiaries while ensuring her assets are distributed according to her wishes.
Special Needs Trusts
A special needs trust is a trust that is created for individuals with disabilities or special needs. It is an excellent instrument for parents with disabled children or individuals whose spouses or other loved ones have disabilities, as it can help ensure their loved ones financial needs are met after they pass away. A special needs trust is designed to protect the beneficiary's eligibility for government benefits by providing additional financial support without disqualifying them due to a temporary influx of assets.
Let's take the example of Tom and Mary, a couple with an adult son who has a disability. Tom and Mary have an estate worth $800,000, including a home and a few investments. If Tom and Mary’s son were to inherit their estate, the tax liability would disqualify him from receiving the government benefits he needs. Tom and Mary want to ensure their son's financial needs are met after they pass away without disqualifying him from receiving government benefits. A special needs trust can be the instrument to meet these goals.
These are just a few examples of types of trusts available to individuals. Depending on the assets in the estate and the goals of the individual will help determine the best type of trust to create.
Conclusion
Estate planning is critical for everyone, regardless of the size of their estate. I hope it’s also clear that your estate plan should be evolving as your life continues to evolve. Any expense incurred by changes to your estate plan can only pay dividends in ensuring as painless of process as possible for those we leave behind. Understanding the different estate planning instruments available can help individuals make informed decisions about their future. When deciding which estate-planning instrument is right for you, consider your estate size, contents, and goals. Consult with an estate-planning attorney like Justin D. Tjaden to help you choose the best option for your unique situation, and rest easy knowing you’ve taken the steps to protect you and your family.