When you're planning for the future after you're gone, one of the most important decisions you'll face is how to pass on your assets. In some cases, a will is enough. In others, a trust can offer more control and potential tax benefits. Each option serves a purpose, but they are structured differently and have different tax consequences.
What a Will Offers for Simpler Estates
Think of a will as a clear set of instructions you leave for your family. It's a legal document that outlines how your assets should be distributed after your death. It's generally easier and less expensive to create than a trust, so it's a common choice for individuals with smaller or more straightforward estates.
The main challenge for your heirs is probate. Because a will is a public document, the court oversees the process, which can be time-consuming and stressful for your family during an already difficult time. In some cases, it can involve additional costs. A will also doesn't reduce your taxable estate, provides no privacy to your beneficiaries, and offers no protection from potential challenges after you're gone.
What to Know About Trusts
A trust works like a private rulebook for your assets, managed by a person or entity you choose (the "trustee"). Instead of leaving a simple list of instructions, you're building a system that can control how and when your assets are distributed, both now and in the future. Because this rulebook is a private agreement, it doesn't have to go through the public court process of probate.
There are two types of trusts used in estate planning: revocable and irrevocable. The type you choose affects how your estate is taxed and how your assets are handled both now and in the future.
Revocable vs. Irrevocable Trusts: A Tax Breakdown
A revocable trust can be changed or dissolved during your lifetime. It allows you to keep control over your assets and adjust your plans as needed. However, because you retain ownership, the assets in a revocable trust remain part of your taxable estate. Any income generated by the trust is reported on your personal tax return.
An irrevocable trust, by contrast, cannot be changed once it has been established. When you transfer assets into this type of trust, you give up control of them. This shift in ownership may remove the assets from your taxable estate, which can reduce estate tax exposure. Irrevocable trusts usually file their own tax returns, and income may be taxed at the trust level or passed through to the beneficiaries, depending on how distributions are handled.
Factors to Consider Before Making a Decision
Choosing between a will and a trust depends on your financial goals, family structure, and the complexity of your estate. Important things to consider include:
- The overall value of your estate
- Whether you want to avoid probate
- Potential exposure to estate taxes, particularly for high-net-worth individuals
- Privacy concerns or long-term financial protection for beneficiaries
- Special needs planning or specific inheritance timing
FAQs
Do all trusts offer tax benefits?
No. Revocable trusts do not reduce your estate for tax purposes. Only irrevocable trusts may offer tax advantages.
Can I avoid probate without a trust?
Certain assets, like retirement accounts or life insurance, can bypass probate if they have proper beneficiary designations. However, a trust provides a more comprehensive way to manage multiple assets.
Does a revocable trust protect assets from creditors?
It does not. Because you maintain control, those assets are still considered part of your personal estate and are subject to legal claims.
Talk to a Professional Before You Decide
Estate planning is never one-size-fits-all. Understanding the tax differences between wills and trusts can help you make a decision that protects both your wishes and your heirs. Consult with an estate planning attorney as well as your CPA to gather all the information you need to make an informed decision.
At Myrick CPA, we help to guide individuals and families through these complex decisions. We'll help you evaluate your options and ensure your financial plan aligns with your long-term goals. Schedule a consultation to learn more about strategic tax planning and how we can help implement those plans.
