For those who have assets to leave as a legacy, a trust can be a strategic part of estate planning. It could include everything from a life insurance settlement and real estate to investments and cash. However, not all trusts are the same—there are many variations, each with specific benefits and restraints.
In the past, establishing a trust was largely viewed as a tool for high net worth individuals looking to preserve wealth across generations. But in recent years, there has been new awareness around the value of creating a trust for asset protection, says Greg Sellers, CPA, and president of the National Association of Estate Planning & Councils. One of the benefits of trusts is that they can shield assets from lawsuits and probate costs. And new ways for trustees to directly manage investments of all sizes are increasingly available with automated investing services, like Betterment.
Selecting the right type for your needs will be something to discuss with an estate planning specialist, such as a financial advisor, accountant, or an attorney.¹ There are some general benefits that most trusts offer. Here is a summary to help you decide whether a trust is right for you.
1. Privacy and protection
After an individual’s death, an estate typically goes through probate, where the will is open for public scrutiny and assets may be used to pay off creditors. If assets are held in multiple states (real estate for example), probate will take place in every state—adding substantial costs to settling an estate. The costs associated with probate can take between 3 and 8% of estate assets away from beneficiaries—not including additional estate and income taxes that could be due during the course of probate.
With certain types of trusts, all assets that have been placed in a trust are considered property of the trust, and thus are off limits to creditors, kept out of public record and out of probate. They are also a useful way to shield and protect assets for people who are a higher risk of litigation, such as doctors. It can also reduce the potential for lawsuits between heirs.
Taxes and trusts have many different facets, and different types offer different tax advantages. For example, an irrevocable life insurance trust shelters life insurance death benefit proceeds from estate taxes. Another kind of trust can be used to establish and build savings for a child by gifting him or her the maximum tax-free gift ($14,000 per donor to each recipient in 2014). Speaking with a trust specialist will help determine the best ways to use trusts for a maximum tax advantages for both the grantor and beneficiary.
The most popular type of trust is a revocable living trust, which is a written document that appoints a trustee to manage and administer the property of the grantor. On its own, a living trust doesn’t minimize taxes but additional provisions, such as a credit shelter trust, can be included to reduce estate taxes.
Overall, trusts can generate savings on both transfer and income tax, including:
- the transfer of future appreciation to the grantor’s heir
- avoidance of transfer taxes
- reduction in size of grantor’s gross estate with charitable contributions
3. Flexible distribution
Not all beneficiaries need the same thing. A trust can establish guidelines for how and when funds are distributed. For example, funds might be earmarked for education, special medical needs, or to be distributed only after the beneficiary has reached a certain age, or distributed at intervals.
4. Sound investment strategy
By law, a trustee has a fiduciary responsibility for the funds entrusted to him or her to oversee. Regulation, such as the Uniform Prudent Investor Act, states that a trustee must act “prudently” when administering a trust, which means holding the investments in a sound interest-bearing account and providing assessment of investment goals, analysis of risk and return, and the diversification of assets. Trustees can be an investment firm or an individual. For all trustees, automated investing services like Betterment have created an easy way to manage a trust in a diversified portfolio for a very low cost.
5. Leaving a legacy
For many people, creating a way to continue to give to important charitable causes or institutions after their passing is valuable. A trust can ensure—through its guidelines—that money is contributed in a specific way or to a specific entity that is not necessarily an heir. This might mean a charity, religious institution, or alma mater. Bequests can also include neighbors, colleagues, former students, friends, and relatives.
¹Note that Betterment is not a tax advisor and nothing in this blog post should be construed as specific advice—please consult a tax advisor regarding your specific circumstances.