When you’re chasing financial independence, you might spend a lot of time tweaking your calculations and investments to reach FI faster. However, one part of financial planning that often gets ignored is estate planning.
Wills and Trusts are important parts of financial planning, yet not enough people know what they do. Here’s a high-level overview of what you need to know.
Wills Are Relatively Simple
Most people think of a will as the main estate planning document that’s needed. While wills are very important, they don’t do nearly as much as most people think. A will is simply a legal document that lets you formally state how you wish for your property to be distributed. It is basically a letter to the probate judge letting him know how you would like your assets distributed upon your death.
Your family can contest this if they feel your decisions were misguided in any way. Uncontested Wills are usually distributed according to the deceased's wishes but if the will is contested then the judge will decide what to do.
Items that need to go through probate are titled items, such as a car, bank accounts, and a house. Things that are legally assigned ownership. The point of probate is to legally transfer ownership from the deceased person to the new owner.
If you have minor children you will also state in your Will who will receive custody of them upon your death. While children certainly aren't “titled assets” the court obviously cares very much where the kids go if their parents pass away.
Things that don't have to go through probate are untitled items, such as jewelry or home furnishing. They aren't legally assigned ownership.
You may still want to include valuables such as jewelry in your Will so that your Will isn't contested. If your sister takes your diamond ring upon your death but your brother feels it should belong to him your brother can contest this in court. Having it specifically stated in your Will will help the courts decide what to do.
Trusts Have Many Benefits
Trusts avoid probate because the trust itself owns the assets. When you set up a trust you transfer ownership of your titled assets to the Trust. Your bank accounts, house, car, etc legally belong to the Trust. You are listed as the trustee which gives you total control over any assets in the Trust. But you are simply the manager, not the owner.
Since the “owner” of the property (the Trust) didn't die the assets do not need to go through probate. Instead, the successor trustee that you previously named takes over as manager. They have total control over how to distribute the assets. Pick someone you trust to follow your wishes.
Trusts are able to distribute assets in more complicated ways. For example, you could specify that little Johnny should receive his assets from the trust when he turns 30 rather than 18. You could also spread out when a person receives money. You could give out 25 percent of a person’s share at ages 20, 25, 30 and 35 to make sure the assets that get distributed aren’t spent all in one place.
Also, if at any time you become incapacitated and can’t manage your own affairs prior to your death, your Trust can specify a backup person that has authority over Trust property. Wills only specify what happens upon your death.
Additionally, if someone wants to challenge your Trust, they’ll usually have a harder time doing so than if you only used a will.
Podcast Episode: Setting Up A Special Needs Trust
Also, Trust information can stay private after your death whereas a Will becomes a public document once filed as part of the probate process. While most people don’t have celebrity status and thousands of people waiting to see how you distribute your estate, this can prevent certain people you don’t want viewing your wishes from gaining access.
If the tax benefits of Trusts are of importance to you, I highly suggest speaking to an accountant before setting up your Trust, but here is a quick rundown.
When you set up a Trust for estate planning purposes you will likely set it up as a “Revocable Trust.” This means you have the option to change or cancel the terms of the Trust at any time. Revocable Trusts don't alter your tax situation while you are alive. The assets are basically still yours and you will pay taxes on them just as you do today.
When you die the Trust will change to an “Irrevocable Trust” meaning the terms cannot be changed by anyone. This does change the tax status. Taxes are paid upon the distribution of the assets and the basis of the assets is set upon distribution. For example, if a beneficiary inherits a house the basis of the house is reset to the value at the time they take ownership. Not the value of the house when it was put into the Trust, or even upon the death of the original owner.
Irrevocable Trusts do have to file a tax return each year.
Trusts Can Be Complicated To Set Up
Setting up a trust can be trickier than setting up a will. Trusts must have a notary public stamp the document for it to be valid which is a higher standard than required by a will. In most cases, you should consult an attorney to properly draft the trust documents, too.
You’ll need to retitle the assets you want the trust to control into the name of the trust. For some assets, you only have to draft a list of what property you want to be included within the trust, then attach that list to the trust documents. However, investments and real estate can make retitling assets more complicated. Ultimately, it depends on the assets you own. This may require professional help as it is better to get the legalities right than to guess.
Trusts And Wills Work Together
Trusts aren’t meant as a complete replacement for a Will. There are a few things Trusts can’t or shouldn’t do that wills can. In particular, Trusts can’t name guardians for children since a court needs to be involved for that. They also can't name property managers for children’s property, name executors, or instruct how taxes and debts should be paid.
If you have a Trust your Will likely be called a “Pour-Over-Will” which states basically “everything I own should go to the Trust.” This will cover any assets you didn't title in the Trust's name.
It’s important you have both a Trust and a Will to take care of every aspect.
The Cost Of Set Up
The cost for setting up a Trust can vary widely depending on how complex your trust needs to be, the assets you want to put into the trust and where you live. Legal Zoom estimates the cost of hiring an attorney to draft a trust can be five to six times the cost of hiring an attorney to draft a will or approximately $1,000 to $2,500.
Additionally, you may have to pay fees to retitle assets from you or your spouse’s name into the trust’s name. While this may be free for some assets, other assets, such as real estate, may have significant costs associated with this change. Check out an interview we did with estate lawyer Mark Moss.
Financial independence isn’t just about the freedom from having to earn money. It’s also about properly setting up your financial life. Now that you’re aware of both wills and Trusts as well as what they do, you can decide which to further investigate for your particular situation.
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