Most people believe that, when they die, the way to pass their assets to their beneficiaries is via a will.  That is not wrong.  But there are downsides to a will.  And there is a better way: via a trust.

In order for assets to pass on to your heirs via a will, the will has to be filed in court in a process called “probate”.  This means that your will is submitted to a court of law.  That makes your will a public document.  Anyone can read your will, see what assets you owned, make a claim to your assets, and challenge the validity of your will in court.  Since the will names your heirs, and the assets to be dispersed to your heirs, this public information now also provides a roadmap to your heirs and their new wealth.  If you leave behind property in multiple states, there may be multiple probate court proceedings.

Moreover, in order to maneuver through this probate court process, and whether or not there is a will contest or outside claims to assets, your heirs will need to hire a lawyer.  The court will make sure that your assets are distributed the way you directed in your will.  And courts work very slowly, which means that those assets may not pass on to your heirs for another year or two, or much longer if there is a court issue, will contest or other probate problem.  In short, if you rely on a will to distribute your assets, you automatically involve the state, which has monetary costs, lack of privacy and delays.

A better mechanism for passing your assets to your heirs is via a trust.  A trust is an entity created to manage assets.  The trust is controlled by a trustee, who manages the property within the trust.  Subject to the terms of the trust, a trustee can invest, sell, buy, lease, mortgage, lend, collateralize, etc., whatever has been placed in the trust, e.g., cash, securities, shares of stock or LLC interests, art, real estate, patents, trademarks, anything of value.  If you establish a trust, and contribute assets to this trust, you may be the trustee over this trust and thus continue to control the assets in the trust while you are alive.  You would also chose a successor trustee.  Because the trust continues to exist after your death, the role of the successor trustee is to control the trust after you die.  The successor trustee, who could be your surviving spouse, relative or trusted friend, would be obligated to follow the instructions you set forth in the trust document, called a trust deed of settlement.  This document will also set forth who inherits your assets upon your death, much like a will directs where your assets are to be distributed at your death.  The people who inherit your assets are called “beneficiaries”.  The trustee has a fiduciary obligation to act in the best interests of the beneficiaries.

However, whereas a will has to go through the probate court process, a trust does not.  At your death, the successor trustee (who you’ve appointed when you created the trust), follows the directives of the trust (which you’ve set forth when you created the trust), including distribution of trust assets to the beneficiaries who you’ve named when you created the trust.  The beneficiaries can be your children, other family members, your alma mater, charities, etc.  Distributing your assets under the terms you’ve set forth could be accomplished by a will through the public probate process, or instead, the very same terms could be satisfied by a trust, privately, without involving the state, without a probate court, without lawyers, and with less of an opportunity for others to challenge the validity of the inheritance terms that you’ve set.

Moreover, because a trust avoids probate and the delays of probate, the successor trustee can step in immediately and administer the trust assets.  The successor trustee can communicate with banks and brokerage firms without a need for court appointment, and can begin to settle the estate and make distributions much faster than if a probate court were involved.  In addition, because banks, brokerage firms and other custodians will freeze an individual account at death, thus complicating the account and delaying distributions and payments, a trust account may continue seamlessly with the successor trustee.  Finally, illiquid assets (e.g., real estate, private investments, private equity, limited partnership interests) that may be complicated by the probate process and require re-titling of the assets after death, can instead continue smoothly in the name of the trust.

The trust is a “revocable” trust, meaning that you have the ability to revoke, or cancel it.  You also have the ability to modify it.  For instance, you can change your beneficiaries or change the trustee.  Because the trust is revocable, the IRS doesn’t consider it to be an independent taxpayer and the trust will not get its own taxpayer ID number.  However, when you die, the trust becomes irrevocable.  At that point, the successor trustee (who you’ve already chosen), steps in and is obligated to follow the terms of the trust that you’ve set forth.

It is more difficult to contest the terms of a trust than the terms of a will.  This is because whereas the will is admitted to a probate court for all to see, nowhere is the trust publicly recorded.  A probate court automatically provides a venue and a mechanism for challenging a will.  Yet, trusts are not public documents and trusts avoid the probate process.

This allows you a greater opportunity to control the terms of distribution, knowing that it will be more difficult for others to challenge those terms.  For instance, you might direct the successor trustee to pursue a certain investment at the exclusion of another.  You might also, for example, set forth pre-conditions for inheritance, such as completing college or graduate school.  If you leave behind a child who is a minor, you can create a sub-trust for that minor, funded with life insurance, IRA proceeds or other accounts payable on your death, and set the terms of that sub-trust, such as delayed distributions at certain ages or periodic support payments over the life of a beneficiary.

An additional important benefit to a trust is that the assets held in trust may be protected from lawsuits, including divorces, and the claims of creditors.  On the other hand, after distribution from a will to a beneficiary, the inheritance is vulnerable to creditors of the beneficiary, including a spouse.

Your will still does have a role in estate planning, even though distribution of your assets is controlled by a trust.  In your will, you set forth your personal representative, who is the person you empower to take care of your funeral arrangements, final personal debts and your last tax return.  This person can be the same as your successor trustee.  If you have children who are minors, the will is also the document to name their guardians in the event both parents pass away before the children reach adulthood.  Finally, the will also should include a provision that any property that you did not address in your trust should now “pour over” into the trust and be subject to the terms of your trust.

Another benefit to a trust is that, if you are married, it preserves both spouses’ exemptions from the estate tax.  Each person currently is allowed an exemption from federal estate tax for the first $5.45 million worth of assets.  In other words, if one’s estate is valued at less than $5.45 million, there is no federal estate tax.  (State estate tax may apply, however, and there is great disparity among exemptions and estate tax rates across all the states.)  That exemption of $5.45 million is now “portable”, meaning that if one spouse did not use up the exemption at death, the unused amount can be transferred to the second spouse and added on to the exemption of that second spouse.  The net effect is a combined federal exemption of $10.9 million for the couple.  On the state level, however, there may not be portability and the exemptions may be much smaller in your state.  Through the use of a revocable family trust, both spouse’s exemptions on the state level could be preserved.  Notably, portability cannot be accomplished via a will.

Thus, while a will has traditionally been thought of as the way to pass on one’s assets at death, wills have significant drawbacks including the probate court process, delays and lack of privacy.  A trust is a better way to accomplish the same inheritance planning, privately, more efficiently, without involving courts or lawyers, with greater control over inheritance terms, and with lower estate taxes.

For information about your estate planning needs, contact Rubinstein & Rubinstein today.