Sit down with any estate planning attorney and the first thing that they will tell you is that you need a trust. Why? A trust may or may not benefit yourself, but it absolutely benefits the estate planning attorney. A will may help an attorney earn a few hundred dollars, where a trust will help that same attorney fund their next tropical vacation. For this reason, you need to be prepared and know if a trust is necessary. Many people don’t need a trust. A will may be enough if you have a modest estate size, most of your assets are in retirement accounts that have beneficiaries, and you are planning on splitting your assets evenly between your kids. Still, for special situations, a trust may be necessary. This article discusses situations in which you should really consider a trust over just a standard will.
A quick note, if you have ever gone through the probate process before here in Michigan, you may still be waking up in cold sweats. One of the biggest benefits of a trust is that it allows your heirs to avoid the probate process. A standard will does not avoid the probate process, but should make the process pretty painless. The bigger issue is passing away without a will or a trust. This article is a quick recap of what would happen if you pass away in Michigan without a will (a.k.a intestate). You may be surprised that your money is automatically split between your spouse and kids, and may not all go to your spouse. If you don’t have a will, at the very least, go get a will created. You have worked too hard to allow the state of Michigan to decide where your assets will go when you pass away.
Now, a few situations in which you should strongly consider a trust.
You are divorced
One of the biggest reasons to get a trust is if you are in the following situation: you are divorced, have kids, and are remarried. Let me tell you about a nightmare scenario for your heirs. You were married and had kids, and now you are remarried and your current wife also has kids from a previous marriage. You update your will and beneficiaries so that your new wife receives your assets when you pass. When you die your new wife now has full access to the money and changes all of the beneficiaries to her children. When she passes, her kids now receive all of your assets and your kids are disinherited! Unfortunately, I have seen this before. One benefit of a trust, is that it gives you much more control when you die. Fortunately, there is a QTIP (Qualified Terminable Interest Property) trust. A QTIP trust allows your remaining spouse to use the income from your assets but the principal passes to your heirs when the remaining spouse passes. This allows your new spouse to maintain her current lifestyle while she is living, but you don’t disinherit your kids in the process. Trust me, your kids will greatly appreciate it.
You have a special needs child
If you have a child that is either physically or mentally handicapped, a trust can continue to offer financial support after you pass. Many times a special needs child cannot support himself financially. A trust can name a family member to continue to assist financially after you are unable. There are two main reasons that a trust can help a family that has a special needs child. First, a trust can appoint a trustee that can help your child spend the money and take distributions from the account. Second, a trust can minimize assets available for your special needs child so that they can still be eligible for government based aid. Often, people with disabilities qualify for government assistance programs like Medicaid and Supplemental Social Security. A large inheritance, not in the form of a special needs trust, can disqualify your children for these benefits. A special needs trust can help you continue to take care of your child, even when you are not able to any longer.
You have significant assets
For the time being, there is still an estate tax. Now, less people are subject to this estate tax as the estate tax exemption has gone up significantly. Twenty years ago, the estate tax exemption was just over $600,000. Meaning that if you passed away with more than $600,000 your assets would be subject to “death” tax. In 2018, that same estate tax exemption is $5.6 million, and for a couple the exemption is a whopping $11.2 million. Also, Trump has discussed doubling this exemption, which would be a nice tax break for his family. Still, if you are fortunate enough to be subject to the estate tax, trusts can help shelter some of these taxes.
For example, you may open up an Irrevocable Life Insurance Trust (ILIT). An ILIT works in the following manner. First, you open a irrevocable trust. Irrevocable means that you can’t make any changes to the trust in the future. Next, you fund the trust with a permanent (whole) life insurance policy. Purchasing the life insurance costs money, which reduces your taxable estate. Next, when you die, the life insurance passes to your trust and eventually to your heirs free of any taxes, including the estate tax. ILITs are just one example of how you can reduce your potential estate tax liability with a trust.
Nervous how your heirs will spend the money
Just because you have been frugal with your spending, doesn’t mean those some traits pass on to your kids. Maybe you have seen a child make bad financial decision after bad financial decision and you know that a large inheritance will be wasted. Maybe you want your kids to have to graduate from college, or reach the age of 30 before you feel comfortable having them inherit a large sum of money. Maybe your kids are caught up in drugs or gambling and know the inheritance will simply be wasted, and even worse could have a negative impact on your children. If you are looking to help a spendthrift trust can cap how much your kids are able to withdraw each year and/or can specify goals needed to be met before receiving any distributions.
For example, you may leave a significant inheritance of $5 million. The spendthrift trust may set forth that the maximum amount that the beneficiaries of the trust can withdraw is $100,000 annually per child. This allows your children to enjoy your legacy without blowing through the assets on expensive cars and houses. Also, because the spendthrift trust limits the income your heirs receive, it also limits the amount creditors can claim against your beneficiaries. This is important if your children have really gotten into financial difficulty in the past and creditors may be knocking on the door. One of the downsides of a spendthrift trust is that you will need to appoint an investment advisor or corporate trustee to manage the assets and make distributions once you have passed, and of course there is a cost for that service.
You have a high profile and don’t want people knowing the details of your estate
There are a lot of great things that a will accomplishes. If you determine that a trust isn’t necessary, a will is a must. Still, one thing a will doesn’t do is avoid probate. If you have gone through probate before, you probably wanted to go get a trust immediately. One of the biggest benefits of leaving your assets in a trust is that the assets in the trust pass to your heirs, while avoiding the probable process. Obviously, this is a huge benefit for your heirs, but it can leave you with some peace of mind as well.
The probable process is ultimately a very public process. Your family, creditors, and the public will have knowledge of both your assets but also your liabilities. Now, for many of us, the public could care less about our estate. For others, the net worth of an individual will make front page news. Neither Prince nor Michael Jackson even had a will when they passed and neither estate is settled today, years after their deaths. Now, I doubt that there are many rockstars worth hundreds of millions of dollars reading this (if so, go get a trust Kid Rock!) but you may prefer the privacy as well. Not to mention, creditors and others can dispute a will during the probate process, but this typically won’t happen with a trust.
Unfortunately, my father-in-law, Howie, passed away earlier in the year. Howie was both well off financially as well as divorced and remarried. Luckily, Howie created a trust to help make settling the estate as easy as possible. He created a QTIP trust so that his wife can live on the interest of his estate while she is living. The principal of the trust will pass to his kids once she passes. He also created the trust in a year in which the estate tax exemption was lower, so the trust was created to help avoid some of the potential estate tax. Also, although he had a fairly complex estate, the trust made distributing the estate quick and painless. Still, not everyone needs a trust. If you have a fairly simple estate, and if most of your assets already have beneficiaries named, a will may be sufficient. Yes, your estate planning attorney may push you to create a trust but that doesn’t mean you actually need one. Let the next family pay for your attorney’s vacation home.