You don’t have to go too far down the path of estate planning before running into questions about wills and trusts.
Do you need both a trust and a will? What’s the difference between the two?
Both wills and trusts are legal documents that govern how your estate’s assets pass on to your heirs. While your will doesn’t take effect until you die, a trust can be utilized while you’re alive.
Wills can be fairly simple, naming a guardian for your minor children, distributing your assets among your heirs, and directing your final wishes.
Trusts are more complex but can provide greater benefit than a will. A trust offers greater control over the distribution of your assets and avoids the probate process. However, a trust must be funded by transferring assets to the trust, making the trust the owner.
Probate
Probate is the legal process for allocating your estate after you die. If you have a will, the probate court will determine that allocation based on your wishes and appoint an executor to administer your will’s provisions. If you don’t have a will, you’re considered to die “intestate” and your estate will be distributed based on your state’s laws. However, those state laws may or may not agree with your wishes.
For instance, in Kansas, if you die with a spouse and dependents, your spouse inherits half of your intestate property and your descendants inherit the other half. So while you may have expected your spouse to receive all of your property until he or she passes away, that’s not how the intestate laws are written.
The probate process can take a few months or up to a year unless the estate is large or the will is contested, in which case the process can drag on for years. Also, probate is public, so anyone can access the information about your estate.
Property Not Subject to Probate
If you have property with a named beneficiary, those assets don’t go through probate. This includes property transferred to a living trust, life insurance proceeds, retirement accounts, real estate with a transfer on death deed, vehicles which have a transfer on death registration, and bank and investment accounts which are either payable-on-death or are held in joint tenancy or tenancy by the entirety.
Joint Tenancy with Right of Survivorship (JTWROS)
This form of ownership is where two or more owners (or tenants) each have an equal, undivided interest in the property. This is a common form of ownership for married couples with bank and investment accounts, real estate, and other personal property. When one of the joint tenants dies, the property’s ownership automatically passes to the remaining tenants.
However, retirement accounts such as IRAs and 401(k)’s cannot be held under this form of ownership, so beneficiary designations should be used with these accounts to automatically transfer ownership upon death.
A benefit of JTWROS is that it avoids probate, as ownership passes outside the provisions of the will. Another benefit is that assets would be available upon death rather than being frozen under probate, unless there was substantial debt involved in the estate.
Be aware that not only assets but also liabilities of the property are held jointly, meaning all owners are responsible for any debts or mortgages on the joint property.
But there are potential issues with non-spouse owners . . .
While this type of ownership is most common for married couples, it can also be used with children or other unrelated parties. Joint owners should be trusted individuals, as all owners have unrestricted access to use the property as they wish.
However, property passed by JTWROS can cause a gift tax liability when the remaining tenant is someone other than a spouse or charity. Gift tax can also be triggered if a non-spouse is added to a JTWROS account with value in excess of the gift tax exclusion for the year, even if the owner is not deceased.
Upon the first owner’s death, a spouse will receive a step-up in value equal to half the value of the asset. However a non-spouse owner will not receive a step-up basis upon death, potentially incurring capital gains tax when the property is sold.
It’s also possible that the remaining non-spousal tenant will not dispose of the property in the way in which the deceased owner intended. For instance, if a parent adds one of their children to a joint bank account in order to assist with paying bills, that child is under no obligation to share the proceeds of that account with their siblings upon the parent’s death.
So be cautious when adding a non-spouse joint tenant.
How can these issues be avoided?
Property placed in a joint revocable trust can still have the same spousal decision and signature requirements as Joint Tenancy while providing some additional benefits: Gift tax can be avoided when transferred to heirs; there may be no capital gains if the property passes at the death of the grantors; and heirs have no control over trust assets.
This is a brief overview of a complex topic, so for advice on your personal situation, visit with a tax or estate planning professional.