We have all heard the cliché that the only guaranteed things in life are death and taxes. While neither of these is pleasant to think about, most of us share a similar sentiment: if anything were to happen to us, we want to make our family’s life easier.
One of the most challenging elements of death is the financial implications that come with it. That could include paying for a funeral or determining where and how to access assets, not to mention the sometimes lengthy process of probate.
Fortunately, there’s a helpful solution: trusts. (And a life insurance policy, but that’s a topic for another time.)
Trusts come in many varieties, but for the sake of this article, we’re going to focus on two of the more popular choices — revocable and irrevocable trusts. These two options can be valuable financial tools for streamlining (or eliminating altogether) the probate process and ensuring your assets are distributed appropriately. The laws governing trusts vary from state to state, and you should check with a licensed attorney or financial professional for specific information about your state’s laws, but here is some helpful information to get you started.
What is a trust?
A trust is a financial entity, legally separated from your estate, that is established in order to protect, grow, and distribute the assets you have accumulated. Your trust holds the assets — like your home, life insurance, investment accounts — and distributes them according to your wishes when you die.
When you put money into a trust, you are called a grantor. Since the money in the trust is not legally yours, the trust must have a manager — called a trustee — whose job is to manage the trust and distribution process.
A trust is designed to legally separate you from the wealth you wish to leave behind. Depending on the type of trust you create, there are numerous potential advantages that come with having a trust and a living will. These advantages include control over your wealth, protection of your legacy, elimination or streamlining of the probate process and estate tax savings.
Doesn’t a will cover all this?
In short, no. A will and a trust serve two distinctly different purposes. While everyone really should have a will, not everyone needs a trust. However, many people could find both beneficial.
A will takes effect after you die and includes indications on who should be the guardian of your children, details of your assets, funeral arrangement preferences, and designations for items that are your property only. Additionally, a will always passes through probate, which means a court will ensure it’s valid and will oversee the administration.
A trust, on the other hand, is in effect while you are alive. It is not a means of naming a guardian for your children or specifying your funeral preferences. Its purpose is to serve as the holder for all your assets with clear instructions for who receives what. In most cases, a trust will not need to go through probate, which, depending on the complexity, can save your family a lot of time and money. Assets within a trust are commonly things like a house, life insurance, retirement plans and more.
A trust does not supersede your life insurance designations. The beneficiary named on your life insurance policy will remain the beneficiary even if you specify otherwise in your trust. You can, of course, name the trust as your beneficiary and then assign your assets according to your preference.
What is an irrevocable trust?
As the name implies, an irrevocable trust is one that you (the grantor) cannot revoke in whole or in part. It can only be modified or terminated with the permission of the beneficiary. The moment a grantor transfers all assets into the trust, the grantor removes his or her rights to access or ownership. For this reason, an irrevocable trust is not considered to be part of your estate for legal and tax purposes.
You may wonder why anybody would choose to create a trust that cannot be revoked, even while they are still alive. After all, what incentive is there for putting your hard-earned money into a place where you can’t reach it?
The main reasons for setting up an irrevocable trust are for estate and tax considerations. The benefit of this type of trust for estate assets is that it effectively removes the trust’s assets from the grantor’s taxable estate. It also can remove these assets from personal liability. For the average person, this is a non-issue, which is why revocable, living trusts are the more common choice.
What is a revocable trust?
A revocable trust, also called a living trust, is one that’s in effect while you’re alive but you can access at any point during your lifetime. The “living” and “revocable” in this trust’s name refer to the fact that you can change them as your circumstances or wishes change, and this distinction is what makes it clearly different from an irrevocable trust.
While you are alive, you maintain control over the assets in the trust. Upon your death, the assets in your trust go to the beneficiaries you named.
Like any living trust, a revocable trust is legally separate from you and comes with specific provisions for how the wealth within the trust should be distributed. This means that the assets within the trust will be dealt with according to your wishes, and usually without the need for court assistance.
At the same time, you can amend or eliminate a revocable trust, which means that you can still access the money within the trust if you really need or want it. For this reason, a revocable trust is still considered to be part of your estate for legal and tax purposes.
While a living trust is an estate planning tool like a will, it gives you more flexibility to decide what happens to your money and other assets during your lifetime and afterward.
A revocable trust may be a better choice in situations where having some control over entrusted assets is more important than the tax advantages and asset protection that come with irrevocable trusts.
“The most important thing to think about when you’re setting up a trust is the purpose of it,” explains Shannah Game, CERTIFIED FINANCIAL PLANNER™ professional and host of the Millennial Money Podcast. “Typically, revocable trusts, or living trusts, are created to take ownership of your assets to keep them protected by the trust during your lifetime and can be changed as often as you like. Irrevocable trusts work to protect your assets from estate taxes and can work as a mechanism to leave money to your beneficiaries, but just as the name implies, are irrevocable and can’t be changed. I find with my clients that, in most cases, a revocable trust satisfies their needs.”
Which trust is right for you?
A revocable trust might be a better choice if you want to:
- Avoid probate while maintaining maximum control. Probate is the process courts use to oversee the disposition of a person’s estate after that person dies. A revocable trust will help keep your assets out of probate court just as an irrevocable trust would. However, it gives you increased flexibility to maintain control over the assets while you’re alive and to make changes as you see fit.
An irrevocable trust might be a better choice for:
- Estate tax reduction. An irrevocable trust permanently gives your estate (or a portion of your estate) to someone else, namely to the trustee and the beneficiaries of the trust. This means that whatever you put into an irrevocable trust cannot be taxed as part of your estate, because it is not part of your estate.
- Asset Protection. Since it is not legally yours, an irrevocable trust is not subject to your personal liabilities. Nonetheless, if you make your children and/or your spouse the beneficiaries of the trust, you can still keep your wealth within your family, even while protecting it from personal liability.
Choosing the right trust
Trusts are a sophisticated estate planning tool that can provide added benefits that a will cannot offer. The reality is that death can be not only emotionally draining but also very complicated. Trusts provide a way to make it a little less complicated through their elimination of the probate process and potentially any tax implications that can come with death. But, keep in mind that the average person does not need to worry about estate taxes due to the high thresholds (millions of dollars.)
If you’re looking to eliminate or uncomplicate the probate process, then a living, revocable trust may be a sound choice for you. If you’re seeking a tax-advantaged option, then you may want to go with an irrevocable trust. Either way, by setting up a trust you’re helping to make someone else’s life easier when the time comes that you’re no longer around. Your deliberate advance financial planning is a gift to your trustees and beneficiaries.
Nikolas Jintri is a writer, musician, mentalist, and educator who teaches rhetoric and critical thinking at Temple University in Philadelphia. He is not an attorney and this is not legal advice.
Haven Life Insurance Agency (Haven Life) does not provide tax, legal or investment advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or investment advice. You should consult your own tax, legal, and investment advisors before engaging in any transaction. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel.