Which is Better: a Will or a Trust?
One of the most frequent questions I receive from clients goes to the very heart of estate planning—the difference between a will and a trust. When creating a trust, most individuals also create a will (usually a pour-over will), which further confuses the issue. When a client seeks guidance from me on whether it is better to create a will or a trust, the short answer usually is: it depends.
A will (sometimes called a last will and testament) is a foundational estate planning document and one that should be considered by every individual. The primary purpose of a will is to provide a set of instructions for the probate court to follow after your death. Basic issues that are addressed in a will are your choice of executors (the person who will be in charge of your estate) and your desired distribution of your property at your death. While a will is essential to any estate plan, by itself a will has two key drawbacks: it does not avoid probate; and it does not address the issue of your incompetency.
By contrast, a trust (sometimes called a living trust) is usually designed to accomplish everything addressed in a will (naming fiduciaries and designating where your assets go upon your death) but also usually provides the added benefits of avoiding probate and allowing the management of your incapacity. Most people want to avoid probate because an administration proceeding generally costs between four to eight percent of the gross value of the assets and take a minimum of nine months, if not several years, to administer. In local cities such as Manhattan Beach or Santa Monica, where home values average close to $1,000,000, probate fees and costs can easily exceed $40,000 or more. A trust also allows incapacity management because if you (as the trust creator or ‘settlor’) are deemed to be incapacitated (such as by a stroke), the trust agreement usually allows your named successor to assume control of your trust estate. Thus with a trust your assets can be managed for your benefit without having to file a court proceeding.
In addition to these foundational benefits, trusts can also be designed to create a host of other benefits for the settlor including some protection from estate taxes, delayed and managed distribution of your assets for dependents, and some protection from potential creditors. All of these benefits usually require that a person spend more money preparing the estate plan, but given the various benefits for most people, the investment is usually money well spent.
In summary, a will-based estate plan is frequently ideal for those with minimal non-real estate assets. For those individuals with real property holdings, dependents including minor children, or a reasonable asset base, a trust-based estate plan usually is the better choice.
Do You Have the Right Kind of Trust?
I have written extensively about the importance of creating a living trust (sometimes called an inter vivos trust) as a centerpiece of your estate plan. A living trust provides numerous benefits including allowing your loved ones to swiftly and privately manage your affairs, in the event of your incapacity or demise, without the assistance of the probate court.
Recently I was contacted by old friends who thought it might be time to review and update the trustee designations in their trust. Over the years, I had spoken many times to these friends about the importance of a having a living trust. These friends had repeatedly assured me that they had a living trust (created before they knew me) and had arranged everything many years earlier. I had even helped these friends when they functioned as trustees of another trust and so they were familiar with the operations of a trust and how it was administered. So imagine my surprise when I reviewed their plan and discovered that my friends’ trust was not a living trust, but rather a testamentary trust, or a trust created by a last will and testament.
The differences between a living trust and a testamentary trust are significant. Since it is created by a will, a testamentary trust only comes into existence through a probate proceeding. A testamentary trust thus requires that your executor apply to the probate court to create the testamentary trust. The probate (and trust) estate is then subject to the extensive costs of probate (generally 4% to 8% of the gross value) as well as the mandatory notice periods that require a probate proceeding to remain open for at least eight to twelve months. In many cases, a testamentary trust is the worst of both worlds because the creator will incur the additional expenses of creating a more complex document and force his or her beneficiaries to wade through the probate process. Moreover, the testamentary trust is only created upon your death and therefore does nothing to help manage your affairs if you become incompetent.
Time and time again I encounter clients who assumed that they had created a fully functional estate plan only to discover when it was too late that the plan was deficient. Frequently these mistakes are by “do it yourselfers” but sometimes the deficiencies arise from simply not reviewing an attorney-created plan for numerous years. When was the last time you reviewed your estate plan? Does it operate in the most efficient manner? Does it include sufficient contingency options to deal with the variety of problems we face in life? If you don’t know, now is a good time to review your plan with a professional.
Does Your Estate Plan Anticipate the Bereavement Effect?
Families are a complex system of support. No matter the generation, there is usually a division of labor between the principals. In the United States, the stereotypical model envisions a husband employed outside of the home while the wife manages the child care and/or household. Increasingly we are seeing a multitude of models, including the wife functioning as the primary earner or the spouses sharing the roles equally.
Whatever the division of labor, it is not unusual for these roles to change within a family overtime. Perhaps one spouse assumes more responsibility for child care when the other spouse returns to school. Or when one spouse loses his or her job, it is not unusual for the other spouse to become the primary earner. It is this flexibility present in most families that serves as a foundation of strength.
Unfortunately, this foundation of flexibility and support can be severely challenged when one spouse dies. Medical research tells us that when illness or death strikes one spouse, there is an increased likelihood that the other is going to face serious medical problems. Referred to as the “bereavement effect”, researchers have found that your health frequently becomes interdependent on the health of your spouse. In a 2006 study published in the New England Journal of Medicine, the authors concluded that an elderly surviving spouse had between a 17% and 21% of dying within the first year following the death of the first spouse.
Many individuals delay or ignore estate planning assuming it is unnecessary because all of their assets will be inherited by the surviving spouse. A number of planning tools—especially the use of joint tenancy—makes the assumption ostensibly reasonable. But what happens in the event when there is a systematic failure in the family? I have counseled numerous families where the spouse that handled the business affairs passes suddenly, and the surviving spouse is unable to assume all of the management. I have also assisted families where the surviving spouse doesn’t know all of the couple’s assets or how they are managed.
Good estate planning anticipates the bereavement effect by attempting to plan not just for death also but multiple contingencies. Good estate planning allows the surviving spouse to find the assets and assume responsibility for the management of them immediately. If the surviving spouse is not capable of the management role, good estate planning includes contingency plans that allow others to assume the management responsibilities. Good estate planning uses tools—living trusts and durable powers of attorney—to avoid the cost and delay associated with probate court. Does your estate plan anticipate the bereavement effect?
