Estate Planning: Is a Will sufficient? – by Syed Nishat

Estate Planning: Why having a Will is not enough? – by Syed Nishat

Among the many facets of financial planning, Estate Planning is one of the most important. However, it also tends to be one of the most neglected aspects for investors who may think that they don’t need to be concerned about it yet. As recent events, including the COVID-19 pandemic, have shown, life is uncertain, and without proper Estate Planning, even something as simple as custody of children can end up being decided by judges or state officials. Most investors believe that by having an up-to-date Will, they have satisfied all aspects of making sure their wishes will be carried out after their deaths. However, is a Will enough to cover everything?

What is a Will?

First off, what is a Will? A Will is a legal document that spells out your wishes for the distribution of your assets and the care of minor children after your death. This is a document someone can prepare on their own, however, having the Will prepared and witnessed by professionals will decrease the likelihood of successful challenges in the future. Wills can be simple or very complex, and their level of effectiveness can vary, depending on the type. Even the most thorough Will rarely covers all the issues that could arise. After the owner’s death, the Estate will go to a probate court to be authenticated before the Will can be processed. Even in a simpler scenario, the legal proceedings could take months to settle everything. However, this can be alleviated by having not only a Will, but also a Trust.

What is a Trust?

So what is a Trust? In basic terms, a Trust is a fiduciary arrangement that specifies how assets should be distributed at the time of the owner’s death without involving probate. Besides this huge benefit, which expediates the carrying out of the decedent’s wishes, there are other major benefits to having a Trust in addition to a Will. There are different types of Trusts, with the two most well-known being the revocable Trust and the irrevocable Trust. A revocable Trust allows the creator the same level of control over the assets within the Trust as they would have in any normal accounts, meaning that can move the assets in and out of the Trust at Will. An irrevocable Trust, on the other hand, is a kind of Trust where the terms may not be modified or terminated without the express permission of the grantor’s beneficiaries, as the grantor has legally removed their rights of ownership to the assets in the Trust and has transferred those rights into the Trust itself.  

Benefits of a Trust:

• Divorce and & Asset Protection for Beneficiaries: In terms of beneficiary benefits, Trusts can provide several protections. For minor children left behind, a Trust can establish guidance over their inheritance until they take control of their monies at majority. Because a Trust has the option of specificity in what is allowed, one can also use it to establish lifetime gifts to a child, to protect assets from a beneficiary who may otherwise use money unwisely by having a Trustee limit access, or to ensure that in the case of divorce, the beneficiary’s inheritance is unavailable to their ex-spouse. Lastly, if one’s beneficiaries are in professions that may be more susceptible to legal action, such as in careers as physicians, it is a good idea to protect their inheritance by keeping those assets in Trust and untouchable by creditors.

• Step-up in Cost Basis: Assets held in Trust for beneficiaries will receive a stepped-up cost basis if the assets are included in the estate of the decedent. At the time of inheritance, the higher market value of an asset is considered for tax purposes. Generally, the value of the asset at that time is greater than it was when the original owner acquired it, meaning a larger tax would be levied on the asset.  A step-up in basis is the readjustment of the value of an asset with an appreciation for tax purposes upon inheritance. When this step-up is applied to the cost basis at this transfer, the tax will be assessed on the changed value. For example, an investor may purchase shares of Apple stock at $5. However, when they are left to the beneficiary, those are now $20. Those shares will receive a step-up in basis, meaning the cost basis for those shares the new market price of $20.  This also means that any capital gains tax paid in future will be based on the $20 cost basis rather than the original $5 purchase price.   

• Dynasty Provisions for Multigeneration Planning: With an eye toward preserving wealth for several generations in the future, a dynasty Trust can be established in some states that allows the person who settles the Trust to control distributions through multiple generations. This type of Trust is irrevocable which, while being less flexible during the creator’s lifetime, provides enormous asset protection for future generations. By limiting beneficiaries’ access to the funds rather than providing for them to receive the funds outright, provisions can be made for a long-term sustainability of the Trust, potentially indefinitely. Properly managed and funded, dynasty Trusts can be tools used to financially support many generations of a family without transfer or estate taxes.

• Protecting Beneficiaries from Themselves: In some cases, the creator of a Trust wants to ensure that their heirs will get the most benefit possible from their inheritance while knowing that those they wish to help most may not be in a good position to handle their own financial affairs. A grantor can included specific clauses into the Trust to create protections, such as age restrictions for fund withdrawals, which could include provisions for installments being taken out at certain ages, and drug testing to make sure the funds will not be used to further endanger a beneficiary.

• Planning for Incapacitation: An important advantage of a living Trust, defined as a Trust that is established during someone’s life and allows for the most flexibility, that cannot be covered in a will is planning for incapacitation. If a Trust is funded during someone’s lifetime, the successor Trustees can access funds to aid with bills to cover that person’s care in ICU or a long-term facility.

• Avoiding Probate: With only a Will and without a funded Trust, one’s family would have to go to court to obtain conservatorship to have access to those funds, with the time and costs associated with those legal proceedings delaying and complicating the process. Seeing circumstances like this, particularly now, it can be beneficial to also have health care proxies and power of attorney documentation on file as well, to make it easier for one’s family in times of stress.

• Avoiding Estate Taxes: Many states have estate taxes that will be levied not just in the decedent’s home state but in any state in which the decedent held real estate. If assets are distributed through an irrevocable Trust as a gift, those taxes may be avoided, which will help to ultimately minimize overall taxes on the estate. While current federal tax rates for estates have been lowered considerably, these cuts will only last until 2026. Even if an estate is not currently subject to taxes, after 2026 the rates will revert. Held in Trust, those assets are not subject to those same estate taxes.

The difference between the Trust and a Will is the controls one can put in place to protect those assets and make sure they are handled after one’s death specifically and immediately. Because there is much to consider with estate planning, it is best to work with an experienced financial advisor when setting up this vital aspect of a financial plan. They will act as a guide and advise which is the best type of Trust to best suit your circumstances and will work with you to see how a Trust fits into your Estate planning to protect your assets and your legacy.