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Trusts vs. Estates: Simplified

Budget and Save

Understanding the Differences for Your Unique Situation

As you begin - or continue - your financial journey, much of your focus and efforts have probably been on investing and saving in order to meet your lifestyle and retirement goals. You’ve no doubt looked at budgeting, savings accounts, and things like 401(k) and IRA accounts. 

More complex issues to consider involve retirement income or the transfer of your assets well into retirement or after you and/or your spouse pass away. 

Understanding the differences between trust and estate planning services is critically important to optimizing wealth management. Trust and estate are considered two sides of the same coin designed to facilitate the seamless transfer and distribution of assets as you move into late stages of life. Believe it or not, trust and estate planning is one of the most overlooked wealth management disciplines.

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, includes assets within a home, cars, real estate, art, jewelry, investments, insurance, and other assets that are part of a person’s net worth. Legally, a person's estate refers to an individual's total assets minus any liabilities.

What is a trust?

A trust is a document that serves legal and financial purposes within an estate plan. With a trust, you select a trustee who will be responsible for distributing your assets to your beneficiaries. Since a trust document is just one component of a comprehensive estate plan, you should consider using it to complement other planning measures that honor your final wishes.

Key Differences Between Estates and Trusts

Estate planning is a comprehensive plan to manage an individual’s assets in their lifetime and beyond. A trust is a legal document where the Grantor of the Trust makes an agreement with a Trustee to manage the Grantor’s assets. The Grantor decides how all of their assets will be managed through a detailed Trust instrument.

A Trust can serve several important purposes:

  • Distribute assets according to a person’s wishes
  • Avoid probate court of a decedent estate
  • Control assets during illness or incapacity

There are many different types of trusts that can be established. Each of these trusts serves a unique and specific purpose. The following types of trusts are common:

  • Revocable Living Trust – This type of trust allows the creator (trustor) to make changes to the document or cancel the trust altogether. As the trustor, you should be sure you always have recently updated documents of your trust.
  • Irrevocable Trust – These trusts work in the opposite manner of the revocable trust. In an irrevocable trust, once created, the trustor nor anyone else is allowed to change the document.
  • Asset Protection Trust – When a trustor has a lot of debt, an asset protection trust can protect the trustor’s assets from being subjected to creditor claims.
  • Spendthrift Trust – This trust serves as a protection measure that operates similarly to an asset protection trust, but it works to protect the inheritance from the recipient’s creditors.
  • Special Needs Trust – This trust is unique because it allows persons with special needs to be awarded their inheritance without impacting their Social Security benefits.
  • Charitable Trust – These trusts prioritize the philanthropic interests of a trustor, often used by the wealthy to reduce tax liability.
  • Constructive Trust – This type of trust may be deemed “in place” by a court. A decedent does not typically create a constructive trust.

When Estate Planning Is More Favorable:

Estate planning offers an exhaustive approach and is beneficial when the individual desires to manage their affairs holistically. If the individual has minor children, a plan can designate guardians for them and ensure their financial support. It also consolidates all of the individual’s information, such as financial records, medical information, and life insurance policies, into one plan to be used when necessary. An estate plan offers peace of mind knowing that a person’s life’s work and family are protected.

When Trusts Provide Better Solutions:

Trusts offer advantages in specific scenarios. For example, one might establish a living trust to avoid the probate process, which can be time-consuming and costly. Trusts provide privacy, as they do not go through the public probate process. In addition, trusts offer flexibility as they can be structured to distribute assets at certain times or events, offering more control over how the estate is managed after one’s death.

The Role of Trustees and Beneficiaries:

  • A trustee takes legal ownership of trust assets, manages the trust, and is responsible for carrying out the purposes of the trust.
  • Beneficiary designations named to receive trust assets, will depend on the trustee for legal expertise, financial savviness, prudence, objectivity, and empathy.
  • When selecting a trustee, it’s important to consider the different types of trusts and associated responsibilities.

How do you choose a trustee?

Most people pick a friend, family member, attorney, or corporate trustee to oversee their assets. Here are some of the factors to consider when choosing a trustee:

Time – Trustees must be prepared to devote enough time to properly manage the trust. Serving as trustee involves a significant amount of work, such as:

  • Filing income and estate tax returns
  • Securing and selling real estate
  • Maintaining property
  • Hosting estate sales
  • Conducting appraisals for personal items, like jewelry and artwork
  • Notifying creditors of outstanding debts
  • Keeping records of trust account activity
  • Communicating with beneficiaries
  • Depending on the type of assets, trustees may have to spend substantial time processing requests, mediating, and making final decisions about distributions. With career, family, and community responsibilities, it can be difficult for individual trustees to quickly respond to time-sensitive, beneficiary requests.

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 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, though they do not have as much knowledge of the relationships between family members, have the ability to make impartial decisions. They operate under the fiduciary duty, which means they act in the best interest of beneficiaries. In addition, institutional trustees provide continuity; trust officers will always be available to administer the trust, whereas individual trustees could become incapacitated or die.

Expertise – Individual trustees, without expertise, can easily make mistakes or mismanage trust assets. Auditors do not review the decisions of individual trustees. Serious errors could remain undetected for years, resulting in heavy fines or lawsuits. Internal auditors and regulatory government agencies check that corporate trustees properly manage trust assets. They review account management processes, compliance procedures, and fulfillment of the fiduciary duty. Typically, institutional trustees include a team of trusted professionals in accounting, law, and compliance and carry liability insurance. They also understand the intricacies of state laws and state estate taxes. 

Cost – Typically, corporate trustees charge fees equal to a percentage of the value of the trust assets. Trust companies or corporate trustees provide all services within one bundled fee. Though individual trustees, like family members or friends, may not require a fee to manage the trust, they may hire professionals to assist them with their decisions and responsibilities. Depending on the types of assets in the trust, individual trustees may need to consult hired attorneys, accountants, or portfolio managers, adding to the overall cost.

The Importance of Designating Beneficiaries

Individuals, charities, and trusts can all be named beneficiaries. In most instances, keep in mind you cannot name children under the majority age (age 18 or 21 depending on your state of residency) as beneficiaries to life insurance policies, retirement plans or annuities. There are also considerations when naming someone a beneficiary who has special needs. 

If you neglect to name a beneficiary on non-retirement assets, the asset will typically be added into 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 will 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 may become part of your estate and be subject to the associated time and costs of that process. Making and maintaining your beneficiary designations allows you to show your love, appreciation, and support for those important to you.

As you plan for late stage financial and legal activities that best protect your assets and execute your wishes, it’s important to know the differences between trust and estate and to understand that the two aren’t always exclusive of each other. 

As important as understanding trust and estate planning, is being organized during your financial journey. Many of us don’t want to think about the circumstances around death or late life issues like declining health or a medical emergency. Please know that your assets are 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 will be stored and how to access them.

It’s also important to provide direction regarding your wishes, who should be notified, and include the names and contact information of anyone who has helped you put this important information together. 

No matter the level of expertise on this subject, it’s helpful to get help from a trusted expert as you explore whether estate planning or a trust is right for you. It’s important to consult with an estate planning professional for personalized financial and legal advice, and to start the trust or estate planning process.

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The information provided in these articles is intended for informational purposes only. It is not to be construed as the opinion of Central Bancompany, Inc., and/or its subsidiaries and does not imply endorsement or support of any of the mentioned information, products, services, or providers. All information presented is without any representation, guaranty, or warranty regarding the accuracy, relevance, or completeness of the information.