A will and a trust are two different estate planning tools. Consider a will like a high-level set of instructions to be used after you pass away. You generally use a will to name the executor of your estate and guardianship for your children. Although you can leave assets to your heirs in a will, it’s not an efficient way to do so, which is why many individuals utilize a revocable living trust. Unfortunately, trusts are often thought of as a tool for only the super-rich, which is one of many misconceptions about trusts that can make this planning strategy underutilized by the everyday affluent.

What is probate?

Probate is a legal process where certain assets that were owned in the individual’s name are distributed by the court. The court will use the will to help guide their distributions and other decisions, but a will can be contested and there’s no guarantee your wishes will be followed.

A retirement account won’t go through probate unless no (living) beneficiaries were named. Life insurance proceeds will also skip probate provided beneficiaries were named (assuming the beneficiary wasn’t your estate). If you have a payable on death (POD) or transfer on death (TOD) on your bank account, then it will generally bypass probate as well. Typically, assets held jointly with rights of survivorship, community property, or tenancy by the entirety will also avoid probate if the joint owner is also living.

Essentially, assets that don’t pass directly to your spouse or heirs include most anything else that you own outright that doesn’t pass via beneficiary designation or a type of joint ownership mentioned above. This can include a bank account, brokerage account, home, car, art, and even interests in a privately-held business.

All probate assets will have to go through probate court before they’re distributed according to your will (if you had one) or at the court’s discretion. Because the probate process can be long and costly, many investors choose to avoid probate whenever possible.

A revocable living trust can help solve many of these problems

Using a revocable living trust instead of a will means assets owned by your trust will bypass probate and flow to your heirs as you’ve outlined in the trust documents. A trust lets investors have control over their assets long after they pass away.

Here are a couple of examples of how a trust can provide additional control and protection of assets after death:

• You and your spouse have two adult children, currently ages 20 and 22. You also have a taxable brokerage account worth $1.5 million. You could put the account in your revocable trust so after you died the account would first go to your spouse and then to your kids if your spouse is no longer living. However, rather than have your kids inherit the money outright, maybe you want to give them each half when they turn 25 and the rest at age 35. Perhaps you also wish to give the trustee discretion to make additional distributions to help pay for a wedding or education before reaching the age milestones. It’s totally up to you.
• Now consider the above example, but you and your spouse also have older children from previous marriages. Depending on your wishes and the dynamic of your family, you may not wish to give your spouse full control over the brokerage account when you pass, fearing your kids from your first marriage may not receive an inheritance at all. In this scenario, a trust could provide options for you to ensure all your loved ones are taken care of.

Trusts can provide tax planning opportunities

Assets held in your revocable trust remain under your control during your life. Because of this, assets are also taxed no differently than if they were owned outside of your trust. At death, certain assets are still eligible for a step-up in basis, even if they’re held in a revocable trust at the time of your death.

Trust planning can also reduce estate tax. The federal estate tax exemption in 2020 is $23.16M and portable between spouses. A handful of states also have a state-level estate tax. Massachusetts has one of the lowest estate tax exemptions in the country—currently $1M—and unlike the federal exemption, it isn’t portable. A credit shelter trust or marital trust could be used after the passing of the first spouse to preserve the exemption.

In this example, assets up to the exemption amount (using $1M as an example) would flow from a decedent’s living trust to a credit shelter trust and any remaining assets would flow to another trust, such as a family trust. If the surviving spouse died later in the year, the credit shelter trust would generally not be included in the taxable estate, which can reduce or eliminate estate tax at the state level altogether, provided the remaining gross estate is $1M or less.

Final word on trusts

Trusts can be a powerful tool to help you accomplish a wide range of goals during your lifetime and long after. Like the rest of your estate and financial plan, you’ll need to periodically revisit your strategy with your attorney to ensure alignment with your current situation, goals, and laws. As evidenced recently with the passing of the SECURE Act, legislative changes do happen which may require you to revisit your plan. For many investors, the relatively small amount of additional upfront work and cost to set up and fund a trust is well worth the benefit to you and your loved ones down the road.