When it comes to creating generational wealth one of the first things considered is creating trust. This asset allows for individuals to pass on wealth through many generations and build upon itself which in return nets the executor of the trust the ability to utilize its funds. This also allows the creator to add in additional layers of protection for wealth building and allows them to manage it even after death. A few things need to be understood regarding a trust.
Advantages and Disadvantages of a Trust:
- Tax Benefits
- Probate Processing
- Court Challenging
- Conservatorship Prevention
- Record Keeping
- Paperwork Requirements
What is a Trust?
A trust is a contract created by an attorney which binds it legal to the original creator. This allows said creator to add in a trustee who then can manage the assets in the trust according to the wishes of the creator. In short term, it allows individuals to add in assets in a legally binding contract in which the day that the individual passes, there can be rules that the trust can follow to keep the assets in the trust growing.
For example, if Person A creates a trust with $1,000,000 worth of assets (liquid in this example) and they pass after the creation of their trust but leave the trustee in charge of investing the funds in low-risk ETFs to net certain yielded dividends then the trustee would follow those orders. If Person A had a child who is Person B and Person A wants Person B to receive 10 percent of the dividends that the $1,000,000 creates per year, then the trustee will pay Person B the 10% of the dividends and then reinvest the other 90% if that were the wishes of the creator of the trust.
This allows for the long-term growth of an asset as there are pros to having a trust which can result in high compound percentages over the duration/life of the trust.
Advantage 1: Tax Benefits
The first thing we need to understand is that there are two types of trusts: irrevocable and revocable. This means that the trust can be amended after they are created (revocable) or it cannot be amended (irrevocable). The type of trust that is normally protected from certain estate tax after the creator’s death is irrevocable.
If we take the above example and create it as an irrevocable trust then Person B would pay tax on the dividend yield that they are gifted per year from the trust but the trust value of $1,000,000 would not be taxed from the inheritance clause of taxation. The 90% dividend earned would be but would be paid out by the trustee. The 10% payout to Person B can also be protected by taxes if it is under $15,000 for an individual or $30,000 for a couple (legally married).
Advantage 2: Probate Processing
This is where having a will and having a trust begin to differ. When an individual has a will, the assets gifted under that will end up going through probate in which they are substantiated and then disseminated to the listed heir of the item. A trust however does not habitually go through probate if everything is correctly created by the creator’s attorney.
Also, a will is public knowledge while a trust is usually selected as private. This is one of the reasons why an individual would want to create a trust to keep documentation private.
Advantage 3: Flexibility
A revocable trust allows for a realm of flexibility at any time during the life of the creator. This gives extra caution for error in case if a life event occurs during one’s life. At any point, the creator can add in a new amendment to adjust the proceeds from the trust to correlate with what is happening in their different life events. If one of the amendments leaves the trustee in charge of a revocable trust after the creator’s death and the creator allowed for them to make amendments, then the trustee can also adjust the trust during the duration of their management.
Advantage 4: Court Challenge
For someone to destabilize a trust that individual would need to prove that the documentation was unenforceable in some way or predisposed by a third party. While wills are sometimes changed the day before death, most trusts require more work, and success results from a well-planned execution. This makes it very complicated for individuals to challenge a trust.
In other cases, a trust is even managed by the creator for years before their death resulting in an impenetrable legal document protecting the assets and wishes of the creator. Additionally, to this, the beneficiary of the trust is entitled to the contents which will create another layer of protection that a will undergoes. A trust does not consider heirs by law as the beneficiary is named from the creator of the trust.
Advantage 5: Conservatorship Prevention
If the creator of a trust becomes incapacitated, then a trust can protect the family from a conservatorship. A conservatorship essentially is when the court appoints a representative to be given authority to manage an incapacitated person’s financial matters. The biggest feature of a trust is exactly that, but the creator has named that well before their incapacitation date. If a trust is set up properly in some circumstances, then the trust can be executed the day the creator is considered incapacitated (individual trust with a successor trustee).
Now with all advantages of a trust, some disadvantages need to be discussed and considered.
Disadvantage 1: Record Keeping
The thing that needs to be understood about trust is that it needs to be maintained during the life of the creator. If that individual is taking funds from the assets or adding additional assets there needs to be accurate record keeping. This allows for a better transition after death for the trustee, but it also allows for the correct profits gained to be taxed accordingly.
Disadvantage 2: Paperwork
A trust does require a lot more paperwork than a will. Because of this, there are additional costs that occurred from the initial paperwork and maintenance costs associated with who is maintaining the trust (think of an investment bank managing the assets in a trust resulting in fees). Each additional item that is added to trust also needs to be documented correctly and paperwork will need to be done. For example, if someone wants to add a property to an already created trust, this will require another piece of the document after the fact of the initial document resulting in more fees and more paperwork.
In conclusion, there are a lot of advantages that outweigh the disadvantages of trust. While a will might be correct for some individuals, trust is going to be bulletproof from a legal standpoint and can allow more control even after death. Make sure to head over to our blog page to see some other documents about financial management.