What is the Difference Between a Will and a Trust?
Some decisions in life you need to make as early as possible. As macabre as it may sound, planning for your death tops that list. It is up there with answering the question “What is money management?” while still in high school. Like an early financial literacy education, you need to deal with your estate planning as early in life as possible.
Whether you have a massive estate or a few worldly possessions, you need a plan for how to handle what you own and its distribution. You also need a plan for your health care should anything happen to you that requires major decisions on items such as life support and resuscitation.
Yeah. Okay. It sounds kind of gross. I know. You probably sit there and read this and think, “Yuck, Carlie. I do NOT need to think about this.” But, yeah, you do.
Not everyone has an early introduction to this stuff, but I did. As the youngest child on either side of a massive extended family, my childhood consisted, essentially, of one funeral after another. My dad was the youngest of seven and mama the oldest of four. Her dad was eight of fifteen. And, yes, that is children, not llamas. The age spread in the family is such that my older sister is twelve years older. Most of my cousins are her age or older. You see where I am going with this, right? No sooner than I was born, they started dropping like flies, my granddad when I was one.
Trust me when I say, you need to plan for this stuff ahead of time. You must. It is not a simple matter, either.
You need to answer huge financial management questions like will you use a will or a trust? What about a living will? Have you ever considered your need for a DNR order? That stands for “Do Not Resuscitate,” if you have not been around a lot of hospitals.
College or your entry-level first job is not too early to start financial planning. You not only need to know the difference between a will and a trust, you need both.
So, let’s start with you need to know this stuff. Yes, it sounds gross. Yes, it can be kind of a downer. The up side is though that once you deal with it, you have it set in stone, so to speak, and your family and friends will be taken care of no matter what happens to you.
The Difference Between a Will and a Trust: The Total Basics
Both wills and trusts let you control the distribution of your assets after death. Establishing one or the other negates obstacles in your estate management. Both options can also ensure that your heirs receive the full benefits of your estate without reduction.
Here’s the deal. If you leave money or property or possessions to your spouse, typically there is no issue. Your spouse can receive the inheritance without gift or estate tax liability due to the unlimited marital deduction provision in the US Estate and Gift Tax Law.
Gifting to your children or grandchildren or others whether using a will or trust creates a more involved situation. Properly titled assets transfer seamlessly, but mistakes on asset titling and beneficiary designations can complicate transfers.
You will need to consult an attorney to conduct title checks, determine the proper wording of any will, testament, or trust, and navigate complex issues such as the creation of an irrevocable trust or interweaving specific types of life insurance into a trust agreement.
Wills
The difference between a will and a trust can seem invisible at times. That probably owes a lot to the fact that a trust can comprise part of a will. A will also stands up in a court of law by itself though. With a will, you direct who receives each part of your estate. With trust, you designate another person to do it for you.
In simplest estate planning terms, a will is a legally enforceable document in which you define how you want your assets distributed after death and how you want your funerary affairs handled. If you have minor-aged children or care for an adult individual as their guardian, your will should also appoint their new guardian. This avoids your surviving family having to petition the probate court for a guardian. The will also puts it in your hands who will care for your child or children since the court could choose someone you would not have.
Something else to consider is how you will pass a portion of your estate to a minor child through a will. A will places your decisions in the hands of the judge presiding over your estate transfer. Your testamentary will carries out your wishes from beyond the grave. A will also allows you to give insight and direction over the handling of assets your beneficiaries will receive.
You can also establish in a will how you want your estate used or, within reason, how your heirs can use their inheritance. Also, as creepy and over the top as it sounds, if you need to disinherit a child, you can do this in a will, as well. The laws on this vary by state, so if it comes to this, you will need to consult your insurance.
You can also disinherit your spouse using a will. The circumstances under which the law allows this vary by state though. Also, the framework used by the state of your residence also contributes to how you can distribute and divide property. The state law framework may make it a common law state, community property state, or an equitable distribution state. This makes a huge difference because you can only disinherit your spouse in a community property state. Each community property state differs as to what and how much property can be disinherited. Using a will is the only method by which you can disinherit a child or spouse.
A Small Plug for Pre-Nuptial Agreements
Regardless of what type of state you currently reside or move to in the future, you can protect yourself from getting ripped off in a potentially crappy marriage by having both parties sign a pre-nuptial agreement before the wedding. These can be as simple or complex as you like.
It also saves you from needing to disinherit a spouse. Most people think of a pre-nup as they are affectionately called as a pre-divorce paper. Dang, they get a bad rap. A pre-nup sets forth a basic contract that protects the finances, property and, in some cases, future earnings, of one or both individuals.
They sound unromantic to some, but they really are a necessity in today’s world. It also serves to protect you in a number of ways and makes a great document to combine with a will and trust.
And?
Well, yeah. Factually, you need both. Also, a warning. A few trust types in and you will want to phone your attorney because their heads do not explode from excess information.
Grab a cup of coffee. Next, we learn about trusts.
Trusts
Got your coffee? Good. Take a swig. This is where stuff gets a little complex.
A trust is also a legal document enforceable in a court of law. The trust document creates a fiduciary relationship between you and another party that names them as the authority that handles your distribution of assets in death to the third-party beneficiaries.
So, yeah. Let’s take it chunk by chunk. Like chocolate. Wait, I have chocolates. (I also have a quirky sense of humor which you know if you read the Goalry set of sites by now.)
That horrid sounding term, fiduciary relationship, just means you give a buddy or bestie financial legal say so in certain matters.
The reason it says “another party” is that the guardian of your trust is not always a person. It could be an organization like your company or the board of directors of it, or it could be the law firm you use.
You would do that because otherwise, every time someone died, you would have to update your trust. Oh, it is not crass. Think about it. Your attorney the first time you hire one, might be in her or his 50s or 60s. You, as a 20-something, name them. Then they die ten years later and you need to name a new trustee. So much easier to simply name, “my current attorney at the law practice of So-and-So and Equally Educated So-and-So and Sons.
Distribution of assets sounds just like you think it does. They will make sure your favorite nephew gets the baseball card collection and your sibling gets the vacation home you are leaving. They also make sure your insurance payout gets disbursed as you wanted and handle doling out any stocks and bonds you own, etc. It is an important job and you need to ensure that you choose a reliable, logical, responsible person.
Third-party beneficiaries. Sounds fancy, huh? That is your family and friends. It also includes the cat charity you want to leave some money.
Now That You Understand the Difference Between a Will and a Trust
Now that you understand the difference between a will and a trust let’s look at why you need both.
While you can create a trust without a will and a will without a trust, they work really well together. A will and a trust go together like peanut butter and jelly, a quarterback and a wide receiver, ice cream and chocolate syrup.
You can create a testamentary trust within your will and that is the most common type of combination.
At the most essential level, you can have a living trust or a testamentary trust. Creating a trust lets you avoid probate court.
1. Living Trust
A living trust defines how you want your assets divided in death and spells out how you want your dependents cared for in your death. This type of trust becomes effective after your death and your will has been entered into probate. The person you name as your successor trustee handles meeting the legal requirements of the distribution you directed.
But, wait; there’s more. You can also create this type of trust to name a successor trustee to manage your estate in the case that you become incapacitated and cannot manage your legal, healthcare and financial matters.
2. Testamentary Trust
With a testamentary trust you bundle the trust into your will. When this happens, the document gets referred to as a last will and testament. The biggest difference is a testamentary trust only kicks in after you kick the bucket. There is no living option for it. You die. Your will gets entered into probate court. Your successor trustee handles distribution. They may have additional duties though. A testamentary trust lets you stipulate that an heir must wait until a specified age to receive their inheritance. For example, you have a minor child and do not want your five-year-old inheriting an instant $150,000. You can specify that they get the money at age 18 or 21 or 25, etc. Until that time, it will remain in trust with the individual you appoint to do so managing it. Since it cannot come into effect until you die, you can make changes to it until you die.
Did you say, “Duh, Carlie?” like my older sister does sometimes? Well, obviously, you did not know that trusts get more complicated. Hmph. You can have an irrevocable trust or a revocable trust.
Also, while your heirs could contest a will, the courts make it much harder to contest a trust. So, take another gulp of coffee and suck it up. Now, we learn about irrevocable and revocable trusts. Also, which ones can be living. Ah…
3. Revocable trusts
Yep. Just like it sounds, this trust you can change. You can make a revocable living trust. That is the most common type. The revocable part really means changeable in this sense not in the sense of dismantling it. You, as the grantor, create the trust. You funnel your property into it. You get to act as your own trustee if you want. You can change the terms of it and transfer all property types in and out of it whenever you like.
4. Irrevocable trusts
You really need to know what you want to do and how you want to do it because irrevocable takes literal terms here. This also can only be a living trust. Once formed, an irrevocable trust exists in perpetuity. You name another party as the trustee. You move your property into the trust and they take care of it and they control it. There is no change. There is no do-over. You had better trust the person or organization you choose as trustee implicitly. As frightening as that may sound, these trusts have gained popularity with high net worth individuals as tax shelters and methods of protecting assets.
You will most likely run into living revocable trusts unless you hang with a jet-set crowd. Here are a few categories of folks who really need to consider irrevocable trusts though.
Entrepreneurs
Songwriters and Recording Musicians
Painters and Sculptors
Authors
Film/Television Actors and Actresses
Are you scratching your head? Did you run out of coffee? Gasp. I did.
Okay, I will just tell you. Those five categories of people could benefit from an irrevocable living trust for their creative catalog after they finished adding to it. It protects their property. Structured properly it can ensure that residuals remain accessible while protecting the larger catalog.
Who recalls the big stink when Michael Jackson passed away over his song catalog? Musicians who write and record their own music represent but one category.
Think of the increase in value that artwork undergoes after an artist’s death at times. Also, consider that these irrevocable trusts can also be living . That means that if something terrible happens to an actor, musician, artist, etc., the items they placed in irrevocable living trust remain protected no matter what. Placing their home in it protects it from being sold off by a desperate spouse.
Okay. You probably get that now. How about an entrepreneur?
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Do I have any readers who have startups?
What happens when you go public? How do you plan to protect your controlling interest in your company? What if something happens to you and you cannot manage the company? With an irrevocable trust, you protect everything you put into it and you have a trustee to manage it. You can protect property from taxes with these. You need a trustworthy trustee, but so long as you have that, you can protect everything.
Final Thoughts
There is why you need both. It is not just about the difference between a will and a trust, but about how they work together. The will only helps you in death with asset distribution. It makes things go faster for your family in probate. It can save them money on probate costs. The trust element helps you protect, manage, distribute, and delay distribution in life and death.
However, in order to get to the point where you decide what to do with your estate, you first need to earn it, meaning you need to build some wealth. One of the greatest ways to do so is to open a savings account. It is an interest-bearing account, with a limited number of transactions. It will help you learn how to save money, and that’s a first step towards growing your wealth. Take a look at some of the best savings account options and find the one that works best for you:
Now, come chug coffee with me again because you still need to learn about the specialized trusts like credit shelter trusts, generation-skipping trusts, qualified personal residence trusts, irrevocable life insurance trusts, qualified terminable interest property trusts.