Pros and Cons of Trusts

If your goal is to ensure the efficient transfer of your assets to your family, you need an estate plan. As you work through the planning process, you have several tools at your disposal, including a will, power of attorney, medical directive, and trusts—all playing a critical role in ensuring your wishes are carried out with the least complications for your executors and heirs.

If you have looked into an estate plan, you may have heard much about trusts. Trusts offer many advantages over a simple will, including:

- Asset protection

- A more efficient transfer of wealth

- Reduced estate taxes and costs

- Preserved wealth for future generations.

However, while everyone can use a will to facilitate an orderly transfer of property, not everyone needs a trust. Trusts can be costly and complex to set up and maintain and may not even be necessary for most people.

Knowing what you want your estate plan to accomplish for you and your family can help determine whether a trust is the right estate planning tool for your situation.

What are Your Goals for Your Estate?

Planning your estate starts with clearly defining your goals and objectives for the plan, which could include:

- Provide financial security for your family: The most critical objective for most people is to secure the finances of their loved ones.

- Care for your minor children: If you don’t name a legal guardian for your children, the state will, and it may not line up with your wishes.

- Asset distribution: Trusts ensure that your assets are distributed as you intended

- Control the distribution of the trust’s assets after death: If you have younger children or adult children who may be irresponsible, you want to control how, when, and to whom your assets are to be distributed.

- Protect against incapacitation: You may want to plan for the possibility that you cannot make your own decisions about your health or finances.

- Minimize estate taxes: If your estate is expected to exceed the estate tax exemption, you will want to structure it to reduce taxes.

- Protect assets: A trust will ensure the maximum benefit for your beneficiaries by protecting your estate against creditors and liability claims.

- Avoid probate: You want to prevent your estate from being exposed to delays, court costs, and the public record.

- Provide for special needs: You want to provide for the proper care and financial support of beneficiaries with disabilities.

- Support favorite charities: You want to include charitable contributions in your estate plan to support causes you care about.

If your estate planning objectives only include the first three—providing financial security for your family, taking care of your children, and distributing assets according to your wishes—your plan could consist of a will with no need for trusts.

You can also add some estate planning tools to address the fourth objective of protecting against incapacitation. Those would include a medical directive to provide explicit instructions for your medical providers and a power of attorney to name a person to make financial and legal decisions on your behalf.

However, you will likely need a trust for the other objectives. A trust is a legal arrangement with a grantor, a trustee, and named beneficiaries.

Remember, there is no one-size-fits-all trust that can accomplish all estate objectives. The various types of trusts have different structures, purposes, and implications for finances, taxes, and beneficiaries.

Here are the five most widely used trusts and their pros and cons:

Revocable Trust

More commonly referred to as a “living trust,” a revocable trust is a legal arrangement that creates a repository for your property and assets. The trust becomes the owner of assets assigned to it by the grantor, which means they can pass to designated beneficiaries outside of probate upon their death.

With a revocable living trust, you can include instructions for the trustee on how the assets will be managed and timelines for when, how, and to whom the assets will be distributed.

When a Revocable Living Trust Might Make Sense

For most people, the benefits of a revocable trust are so minimal they may not be worth the time and expense. For example, if you and your spouse jointly own your assets and plan to leave them to each other, there’s no need for a trust because those assets pass outside of probate.

You also do not need a revocable trust if all your assets are held in accounts with designated beneficiaries, such as brokerage, retirement, or bank accounts. The same is true if your total estate is worth less than $50,000 with no real estate, as it can bypass probate with a simple, out-of-court process.

Here are the circumstances in which a revocable living trust may make sense:

- You want to treat beneficiaries differently

- You want to distribute assets according to a timetable

- You own out-of-state properties

- You own many assets (more than $100,000, including real estate)

- You want to avoid the cost, delays, and publicity of the probate process

- You own a business

Even if you meet these criteria, it would be essential to understand the pros and cons of a revocable living trust before going through the time and expense of creating one.

Revocable Living Trust Pros & Cons

Pros	Cons
Avoids the probate process Keeps the probate court proceeding out of public records Maintains control over assets and how they’re managed and distributed Provides flexibility to modify or revoke the trust while alive	Is more expensive than creating a will but still relatively inexpensive compared to other trusts Is more complex than a will, requiring more planning and management Has no tax benefits as both estate and income taxes are treated similarly to a will-based plan

Irrevocable Trust

As the name implies, an irrevocable trust cannot be revoked once created and funded. That’s a double-edged sword that produces its greatest benefit—removing taxable assets from the estate while making them available to your heirs—as well as its biggest drawback—it cannot be modified or canceled without the permission of the beneficiaries.

Once your property is transferred to the trust, it is owned and controlled by the trust, effectively removing it from the grantor’s estate and reducing the taxable estate. An irrevocable trust makes sense if your estate is worth more than $12 million and you do not anticipate needing to use the assets you transfer to the trust.

Many estate planners recommend owning a life insurance policy inside an irrevocable trust to keep the death benefit proceeds becoming part of the taxable estate.

Irrevocable Trust Pros & Cons

Pros	Cons
Can protect assets from creditors, lawsuits, and legal claims Can reduce estate taxes Can be used in Medicaid planning to help qualify for long-term care benefits Gives the grantor control over the distribution of assets	Takes managing control over trust assets Is complex and costly due to legal, trustee, and administrative fees Cannot be altered, modified, or revoked without permission from beneficiariesIncludes income tax implications (trust income may be subject to higher tax rates)

Unified Credit Trust

Also referred to as a marital or bypass trust, a unified credit trust is typically used to maximize each spouse’s unlimited marital deduction. Under estate law, each spouse is allowed an unlimited exemption for transferring assets to each other. Using the trust, a couple can effectively double their combined estate tax exemptions, thereby reducing or eliminating the estate taxes due upon the second spouse’s death.

Unified Credit Trust Pros & Cons

Pros

Cons

Provides potential for significant estate tax savings
Helps preserve family wealth by ensuring that taxes do not unnecessarily deplete assets
Retains grantor’s control over asset distributionAssigns assets to the trust are generally protected from creditors of the beneficiaries
Trust provides continuous management of assets, which can be especially beneficial if the surviving spouse is not adept at financial matters

Complexity and cost require thorough planning, legal expertise, and ongoing administration
Trust becomes irrevocable after the first spouse passes and the trust is funded
Rigid structure of the trust can limit the surviving spouse’s ability to access trust assets
Trust assets are still subject to income and capital gains taxes

Charitable Trust

Several different trusts can be used to further a person’s philanthropic aims while still benefiting from them currently. Two of the more widely used charitable trusts are charitable remainder trusts (CRTs) and Charitable Lead Trusts (CLTs)

Charitable Remainder Trusts (CRTs)

CRTs provide income to the donor or other beneficiaries for a specified period, after which the remaining assets go to charity. Grantors receive a current tax deduction based on the present value of the remainder interest to be accepted by the charitable organization. Assets inside the trust grow tax-deferred.

Charitable Lead Trusts (CLTs)

Conversely, CLTs generate income for the charitable organization for a specified period. At the end of that term, the remaining assets are returned to the grantor or their beneficiaries. Beneficiaries benefit from reduced estate and gift taxes on appreciated assets.

Charitable Trust Pros & Cons

Pros	Cons
Provides charitable tax deduction for the contribution Assets are exempt from estate and capital gains taxes Allows donors to leave a lasting legacy while benefiting themselves or their beneficiaries Trusts are managed by professional trustees	Most charitable trusts are irrevocable Legally, financially, and administratively complex and expensive to set up and maintain Charitable trusts are subject to strict regulatory oversight Limits control over how funds are managed and distributed

Special Needs Trust

A Special Needs Trust (SNT) is a legal arrangement that provides financial support for family members with disabilities without risking their eligibility for government benefits.

A trustee is named to execute the agreement per the grantor’s instructions, including managing the funds and collaborating with guardians and caregivers to apply funds. The trust must also be coordinated with the parent’s wills and their state’s disability laws to ensure full compliance with benefit requirements.

Since assets held in the trust are not considered the beneficiaries property, SNTs are particularly beneficial for individuals who rely on Medicaid, Supplemental Security Income (SSI), and other public assistance programs. SNTs are established to manage funds for the beneficiary’s benefit, ensuring their needs are met while preserving their eligibility for essential services.

Special Needs Trust Pros & Cons

Pros	Cons
Preserves the beneficiaries’ eligibility for means-tested government benefits like Medicaid and SSI Covers costs of services and items not covered by public benefits, such as personal care, education, and medical expenses not covered by Medicaid Often managed by experienced, professional trustees	Can be expensiveInvolve complex legal and financial regulations Mismanagement can lead to losing government benefits Are irrevocable, leaving little flexibility if life situations change

Bottom Line

Whether your goal is to provide for your family’s financial security or preserve your legacy for future generations, planning your estate is vital. For most people, a will, power of attorney, and medical directive are all needed. However, you may need a trust if you have substantial assets or complex family circumstances.

A properly structured trust can optimize your estate by reducing estate taxes, protecting your assets, and ensuring the efficient distribution of your wealth. However, trusts can be complex and costly to establish and maintain.

Understanding which type of trust can address your needs and its financial, tax, and family implications is essential. ARQ Wealth Advisors are experienced in all planning disciplines and would welcome the opportunity to discuss your estate planning needs in a no-obligation consultation.

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