Wills vs. Trusts: An Overview
Trusts are legal arrangements that protect assets and direct their use and disposition in accordance with their owners’ intentions. While wills take effect upon death, trusts may be used both during the life and after the death of their creators. Separately or together, wills and trusts can serve effective estate planning.
This article will examine how these estate-planning tools can provide for your heirs, including:
The need for a will, a trust, or both
The different types of trusts
The advantages and disadvantages of wills and trusts
When creating a will or a trust, you should consult tax, investment, and legal advisors.
A will is a legal document that spells out how you want your affairs handled and assets distributed after you die.
A trust is a fiduciary arrangement whereby a grantor (also called a trustor) gives a trustee the right to hold and manage assets for the benefit of a specific purpose or person.
Trusts can have a limited term, the duration of the grantor’s or another person’s lifetime, and can hold assets and distribute them after the grantor’s or other person’s death.
If you die intestate (i.e., without a will) and have made no other estate planning provisions, the distribution of your assets will be determined by state law.
A will is a document that directs the distribution of your assets after your death to your designated heirs and beneficiaries. It also can include your instructions for matters that require decisions after your death, such as the appointment of an executor of the will and guardians for minor children, or directions for your funeral and burial. A will can direct an executor to create a trust and appoint a trustee to hold assets for the benefit of particular persons, for example, for minor children until they reach majority or a specified age.
A will must be signed and witnessed as required by state law. Its implementation requires a legal process. It must be filed with the probate court in your jurisdiction and carried out by your designated executor. The document is publicly available in the records of the probate court which oversees its execution and has jurisdiction over any disputes.
Trusts are legal arrangements that provide for the transfer of assets from their owner, called the grantor or trustor, to a trustee. They set the terms for the trustee’s management of the assets, for distributions to one or more designated beneficiaries, and for the ultimate disposition of the assets. The trustee is a fiduciary obligated to handle the trust assets in accordance with the terms of the trust document and solely in the best interests of the beneficiaries.
Unlike wills which take effect upon death, trusts become effective upon the transfer of assets to them. A “living trust” can be created during a grantor’s lifetime. Or a trust may be a “testamentary trust” created after death in accordance with directives in the decedent-grantor’s will. Trusts are frequently used in estate planning to benefit, and provide for the distribution of assets to, the heirs of the grantor.
In addition, trusts can be created to serve a variety of purposes, both before and after the death of the grantor. During their lifetimes, grantors can create revocable trusts which they can alter, amend, or terminate at any time. A grantor of a revocable trust can serve as its trustee. The grantor effectively continues as the owner of the trust assets for tax purposes. The trust document can provide for a successor trustee, for example, upon a grantor-trustee’s death or disability, and include instructions for the subsequent management and transfer of the trust assets. Assets in a revocable trust pass outside of probate. However, because the grantor retains control of the trust while alive, the assets are included in the grantor’s taxable estate.
On the other hand, grantors give up their ownership rights to assets when they transfer to them an irrevocable trust, i.e., one which they do not control and cannot alter. Irrevocable trusts are managed by a trustee who is not the grantor. Provided the grantor has given up all control and beneficial interest in the trust assets, the income from the trust assets is not included in the grantor’s taxable income nor are the assets included in the grantor’s estate. If properly structured, the transfer of assets from the grantor to the irrevocable trust may protect the assets from the grantor’s creditors.
Same-sex couples who are in long-standing, romantic relationships but not legally married, who die without a will, are at risk of the state deciding who gets their assets. Therefore it is critical to make a will or a trust in order to ensure the surviving partner is recognized and protected financially.
Special Purpose Trusts
In addition to providing for your heirs, estate plans often involve arrangements to support charitable purposes or address special family circumstances. Federal and state laws establish rules for creating trusts for specified purposes. Charitable trusts and “special needs trusts” are two types of trusts generally established during their grantors’ lifetimes.
The tax law provides special benefits for certain irrevocable trusts that benefit charities while providing some economic return to their grantor or beneficiaries. Charitable lead trusts and charitable remainder trusts that meet the tax code's technical requirements can serve these dual purposes. These trusts' creation, management, and termination are subject to complex tax law requirements.
Charitable lead trusts are established for the life of one or more individuals or a specified term of years. The grantor transfers assets to the trust, supporting regular payments to charities. When the charitable lead trust's term ends, the remaining assets are distributed to the noncharitable beneficiaries, for example, the grantor's family members. These trusts can be set up during the grantor's lifetime or according to a will. Depending on the trust structure, it may afford the grantor a partial tax deduction upon its creation, provide estate and gift tax benefits, or, in some cases, realize taxable income for the grantor.
A charitable remainder trust is an irrevocable trust that provides current income to the grantor or other designated noncharitable beneficiaries and a partial tax deduction based on the valuation of the contributed assets. The contributed assets are distributed to one or more charities upon expiration of the trust's term, which may be a term of no more than 20 years or a term based on the life of one or more noncharitable beneficiaries.
Special Needs Trusts
Persons concerned about the financial needs of individuals with disabilities (i.e., “special needs” that prevent or limit their ability to provide their economic support), can create “special needs trusts.” Special needs trusts are legal arrangements that enable such individuals to receive financial support from the trust for particular purposes without jeopardizing their eligibility for federal and state public assistance programs, such as Supplemental Security Income (SSI) and other benefits. Because these trusts must meet complex requirements set by federal and state laws, legal experts should be consulted to ensure that their formation and operation will not disqualify the beneficiary from public assistance.
Considerations for Estate Planning
Although estate planning often is viewed as a concern for older individuals with substantial means, it is a subject that almost everyone needs to address. Even if your assets are limited to a residence, bank accounts, and perhaps an IRA or 401(k) account, you want to be sure that the people you wish to receive them do indeed become their owners and that your plans are executed with the greatest efficiency and least expense possible. And if you have complicated personal relationships, for example, children from more than one marriage, a dependent parent or relative, or offspring whose financial resources vary greatly, leaving clearly expressed, and in the circumstances, clearly explained directions for distributing your assets might prevent potential disputes among your heirs.
Many online will makers offer tools for generating legal forms and documents that can introduce you to estate planning options. However, experts recommend consulting legal counsel and other appropriate experts, as needed, to take into account your estate planning needs.
Considerations for Making a Will
The idea of making a will frequently raise an uncomfortable awareness of death. But it also should prompt consideration of your responsibilities to your survivors and, if your financial position permits, your charitable or community interests. In directing the disposition of your assets and expressing your intentions, a will provides your survivors' guidance for handling your estate and lessens the possibility of disputes. In your will, you can designate an executor whom you consider competent and trustworthy.
If you die intestate (without a will), the probate court takes jurisdiction over your estate, appoints an administrator and determines what happens to your property, bank accounts, securities, assets, and even the guardianship of your minor children based on the intestacy laws in your state. It can lead to long court battles, delay property distributions, and result in substantial expense for your heirs and beneficiaries.
If You Die Without a Will
If you die without a will, the post-mortem management and distribution of your assets, the handling of your debts, and the care of your minor children and other dependents will be dependent upon your state’s intestacy law and an administrator appointed by the probate court to manage your estate. Generally, these laws allocate a significant portion of the estate to your surviving spouse and divide the remainder equally among your children. They do not consider factors that might influence you to divide your estate unequally among your heirs.
Your surviving spouse or a qualified adult relative or friend may apply to the court to be appointed as the administrator, but their appointment is not certain. Moreover, intestacy entails probate court processes, time, and professional fees, which could be lower if you die leaving a will and well-designed estate plan.
Accordingly, making a will that appoints your executor, determines who will receive your assets, and expresses your intentions on guardianships, charitable contributions, funeral, and burial should not be a late-in-life decision. Even if you are young, once you have assets and responsibilities to a spouse, children, and other dependents, you should have a will or other legal arrangement to determine the distribution of your assets and to help your survivors make decisions about other matters. You can revise a will during your lifetime as your personal or financial situation evolves or if changes in the law affect your planning.
Although children (natural or adopted) have a statutory right to inherit, a will allows you to disinherit a child if you choose to do so. To be effective, provisions for disinheritance must comply with state laws whose requirements vary. In states with community property laws, varying and detailed rules enable a person to disinherit a spouse. So you need to be aware of your state's laws—whether it is a common-law state, a community property state, or an equitable distribution state. Note, too, that a person can only disinherit a spouse or child through a will.
Trusts, Retirement Accounts, Lifetime Gifts
You should be aware of other legal arrangements that can facilitate transferring assets directly to your heirs. These can include a trust that holds your assets and provides for future transfers, beneficiary designations for retirement and other financial accounts, and gifts of funds and other assets during your lifetime. These arrangements transfer property without the assets going through probate. And, you may transfer ownership during your lifetime through gifts.
Considerations for Using Trusts
Trusts are frequently used in estate planning. "Living trusts" created in the grantor's lifetime facilitate the transfer of assets to heirs without the cost and publicity of probate. Transfers by trust can usually be quicker and more efficient than transfers by will. Such trust transfers enable grantors to maintain privacy concerning the nature and value of their assets. They can be used to keep the differing values of assets passed down to different heirs confidential. Ensuring privacy for family businesses and real estate held through entities not publicly identified with their owners are additional reasons for using trusts.
Establishing a trust to hold and distribute assets upon your death does not protect the assets from estate taxation if your estate's value exceeds the federal estate tax exemption, set at $12.06 million for an individual decedent in 2022.
If the value of your estate is not significant or your assets limited and straightforward, say, your residence and financial accounts, creating a trust to avoid probate may not be beneficial and could cost more than it is worth to create and manage. Although the use of wills can also be costly, trusts can involve more substantial costs. Using a trust entails legal expenses and the cost of transferring property titles to the trust. There also are expenses for ongoing asset management and legal compliance.
Many assets, for example, IRA and 401(k) retirement funds, can be transferred outside probate. During your lifetime, you designate your beneficiaries for such accounts with your bank, investment adviser, or employer, as the case may be. Properly structured and documented, married couples' joint ownership of bank accounts and real estate can provide a right of survivorship that does not require probate.