Estate planning is a complex and multifaceted process, so it’s unsurprising that there is often confusion when it comes to estate planning tools such as trusts. Not only are there many different kinds of trusts, but setting up a trust involves extensive legal documentation, ongoing administration, and tax implications. This article highlights and explores some of the most common misconceptions or “myths” related to trusts and trust planning. But first, let’s briefly talk about what trusts are and why people use them.
A trust is a legal arrangement that allows a person (a grantor) to transfer assets to a trustee to hold for one or more beneficiaries. Examples of assets that you might place in a trust include bank accounts, investment accounts, real estate, personal property, and digital assets.
Trusts serve several different purposes, including the following:
- to control exactly how and when your assets are distributed,
- to protect assets from creditors,
- to facilitate gifting assets to minors,
- to avoid the probate process, and
- sometimes, to provide tax benefits
With that being said, below are four myths about trusts that we feel need debunking.
Myth #1: Trusts always reduce income taxes.
While it’s true that under certain circumstances, trusts may reduce income taxes, frequently this is not the case. Irrevocable trusts that distribute income to beneficiaries in lower tax brackets may reduce the overall tax burden; however, since the tax brackets for trusts are condensed, the overall tax burden may be higher—especially if distributions are not made to beneficiaries, or if there are significant capital gains. Revocable trusts, on the other hand, offer no income tax advantage. Because the assets remain part of the grantor’s estate, all income is reported on the grantor’s personal tax return. So, in short, more often than not, trusts do not reduce the income tax burden.
Myth #2: Family members always make good trustees.
When faced with the task of naming a trustee to manage your trust, you may think the safest option is to select a trusted family member for the role. While a relative may be familiar with your family’s dynamics and values, and selecting a family member may save you the cost of hiring a professional trustee, there are some potential drawbacks associated with this route. Family members serving as trustees often lack expertise in managing and investing assets. Family members may also have difficulty making objective and unbiased decisions, or may even have a personal interest in family assets, leading to a conflict of interest. Additionally, the duties associated with trusteeship can be time-consuming and burdensome for the selected family member. It’s important to consider these factors before choosing a trustee. Hiring a professional trustee to manage your trust, while more costly, can help to avoid many of these potential complications.
Myth #3: You don’t need a will if you have a trust.
You may think that because you have set up a trust to transfer your assets, you do not need a will. After all, wills are only effective after your death and may be subject to the lengthy probate process that trusts avoid. However, a will serves other important purposes besides dictating the distribution of assets, such as designating guardianship for minor children and naming an executor. In addition, a will dictates what happens to any assets not included in the trust. For these reasons, it’s recommended that everyone create a will—even if they already have a trust.
Myth #4: Trusts are only for the wealthy.
Trusts are often associated with the wealthy; however, a trust can be a useful part of anyone’s estate plan, regardless of income. Trusts provide many of the same benefits—such as control over asset distribution, probate avoidance, and legal protection—for all individuals, regardless of net worth. Trusts can be especially useful tools in specific situations, such as for a parent with a special needs child. However, while there is no minimum asset amount required to set up and maintain a trust, doing so often involves considerable costs (i.e., attorney costs, trustee fees, tax professionals), which may be prohibitive to some. It’s important to ensure the benefits outweigh the costs of setting up a trust.
Stick with the Facts and Partner with RBT
At RBT CPAs, we help you distinguish between the facts and the myths and work with you to develop an estate plan that works for your unique needs. Call us today and find out how we can be Remarkably Better Together.