As you begin—or continue—your financial journey, much of your focus and efforts have probably been on investing and saving to meet your lifestyle and retirement goals. You’ve no doubt considered budgeting, savings accounts, and options like 401(k) and IRA accounts.
More complex issues to consider include managing your financial needs in the event of incapacity and the transfer of your assets after you and/or your spouse pass away.
Understanding the differences between a trust and an estate—and the expertise and services necessary for establishing and administering each—is critically important for optimizing wealth management. Trusts and estates are considered two sides of the same coin, designed to facilitate the seamless transfer and distribution of assets.
What is an estate?
Most of us grew up thinking of an estate as vast land and dwellings, often belonging to a prominent family. However, in the financial and legal sense of the term, an estate refers to everything of value that an individual owns. This can, and often does, include the contents of a home, vehicles, real estate, art, jewelry, investments, insurance, and other assets. An estate is managed by an executor, also called a personal representative, who is nominated by you in your Last Will and Testament to administer and transfer assets under court supervision.
What is a trust?
A trust is a legal document that expresses your wishes even through incapacity or death and serves as the trustee’s roadmap for administering and transferring wealth. A trustee, nominated by you in your trust, is responsible for carrying out fiduciary duties, one of which is distributing your assets as set forth in your trust to the individuals, entities (such as another trust), and/or charitable organizations you name as beneficiaries. A trust is just one component of a comprehensive estate plan that complements other planning tools. Any assets titled in the trust’s name avoid the probate process.
What Is a Typical Probate Process?
Probate of your will is the distribution of your probate estate under the supervision of the Probate Court in the county of your residence at your death. Unfortunately, probate can be public, time-consuming, and expensive. All documents relating to the probate of your estate, including the terms of your will, are public and subject to inspection by anyone who wishes to look at them. A typical probate estate is finalized somewhere between 9 and 12 months; or longer if a contest or litigation is filed. Keep in mind that every state has its own unique laws regarding probate.
How to Avoid Probate
If the goal is to avoid probate, a revocable living trust is a great tool to utilize. A trust is a legal document created by you, the grantor, with the assistance of a qualified estate planning attorney. The trust names the trustee (the person, organization, or a combination of both that administers the trust) nominated by you and the beneficiaries you choose to benefit from the assets held in trust. It really doesn’t change the way you do business if you nominate yourself as trustee: you still spend your money as you wish and file the same tax returns. The only difference is that assets which cannot be automatically transferred by designating a beneficiary should be titled in the trust’s name instead of your own name. Your attorney can help sort this out, as each state’s laws are unique. Trust-owned assets are not subject to the probate process, and trusts can survive your death, continuing for future generations.
Types of Trusts
There are many different types of trusts that can be established. Each of these trusts serves a unique and specific purpose. Your attorney can help you decide which trust, or combination of trusts, is right for you.
How do you choose a trustee?
Most people nominate a friend, family member, attorney, corporate trustee, or a combination to administer their trust. There are several factors to consider when choosing a trustee:
- Time
Trustees must be prepared to devote enough time to properly administer the trust and manage its assets. With career, family, and community responsibilities, it can be difficult for individual trustees to quickly respond to time-sensitive matters. Serving as a trustee involves a significant amount of work, including, but not limited to:- Filing trust income tax returns
- Filing estate tax returns, if necessary
- Securing, safeguarding, and managing the disposition of assets such as real or tangible personal property
- Maintaining property to its current condition
- Conducting appraisals for and obtaining valuations of all trust assets
- Notifying creditors of their right to file claim for outstanding debts
- Keeping records of trust account activity
- Communicating with beneficiaries
- Responsibility
One responsibility of the trustee is to oversee distributions to beneficiaries. Some trusts may provide specific instructions about the nature of permissible distributions, but often, trustees will have to decide which distributions are appropriate. Trustees who have personal relationships with beneficiaries may struggle to make objective decisions. Complicated family dynamics, especially when paired with grief, can make this responsibility more difficult. For example, a trustee may be required to withhold funds from a financially irresponsible relative but may fear that the decision will hurt their relationship. Corporate trustees have the ability to make impartial decisions. In addition, corporate trustees provide continuity; trust officers will always be available to administer the trust, whereas individual trustees could become incapacitated or die. - Expertise
Individual trustees, most without expertise, can easily make mistakes or mismanage trust assets. Significant errors could remain undetected for years, resulting in heavy fines or lawsuits. Internal auditors and regulatory government agencies ensure that corporate trustees are acting appropriately by reviewing account management processes, compliance procedures, and the fulfillment of fiduciary duties. Typically, corporate trustees employ a team of trusted professionals in trust administration, estate settlement, accounting, law, and compliance. - Cost
Typically, corporate trustees charge fees equal to a percentage of the value of the trust assets. Trust companies or corporate trustees usually provide all services within one bundled fee. Although individual trustees, like family members or friends, may not require a fee to manage the trust, they may hire professionals separately to assist them with their decisions and responsibilities, which typically increases the overall cost of administration.
The Importance of Designating Beneficiaries
Individuals, charities, and trusts can all be named beneficiaries. There are special considerations for naming children under the majority age (age 18 or 21, depending on your state of residency) and individuals with special needs as beneficiaries.
If you neglect to name a beneficiary on non-retirement assets, the asset will typically be added to your estate and distributed according to your will. Retirement assets, such as a 401(k), get a little more intricate. If you have not named a beneficiary, the assets will be distributed according to the administrator’s plan document. If you are married, they may go to your spouse. If you are not married, they may go to your estate. Similar results may occur if your named beneficiaries (primary and contingent) predecease you and you haven’t updated your designations.
Making and maintaining beneficiary designations is an essential part of everyone’s financial plan. Neglecting your beneficiary designations might mean that assets that typically avoid probate could become part of your estate and be subject to the associated time and costs of that process.
Closing
As you plan for late-stage financial and legal activities that best protect your assets and execute your wishes, it’s important to understand the differences between trusts and estates and to recognize that the two aren’t always exclusive of each other. It’s also crucial to understand the probate process in your state and how it impacts your unique needs and desires.
Regardless of what plan is right for you, being organized during your financial journey is critical to success. Many of us don’t want to think about the circumstances surrounding death or late-life issues like declining health or a medical emergency. Your assets may be at risk if you’re not organized early in your journey. Gather important information and documents in one secure place, such as a safe in your home or a safe deposit box at your bank, and let a close family member know where they are stored and how to access them.
It’s also important to provide direction regarding your wishes, specify who should be notified, and include the names and contact information of anyone who has helped you put this important information together.
No matter your level of expertise on this subject, it’s imperative to consult with an estate planning professional for personalized legal advice.