The Differences Between Life Estates and Trusts

These planning tools also dictate how you can distribute those assets to your specified beneficiaries both during your lifetime and after your passing.

Life estates and trusts can be helpful for the following:

• Lowering your tax liability and assets during retirement in certain situations
• Providing a solid financial future for your loved ones
• Simplifying the probate process for your estate

Each form of estate planning has benefits and limitations. With legal advice from an elder law attorney or estate planning lawyer, you can decide whether a life estate or trust aligns more with your goals.

Living Trusts

A trust involves three different types of people, each of whom plays a unique role. The settlor (or grantor) is the creator of the trust. The settlor is the original owner of the assets that fund the trust. They decide who will manage the trust.

The settlor also determines the beneficiaries of the trust. A beneficiary is a person who will benefit from the funds provided for by the trust.

The person in charge of caring for the assets within the trust is known as the trustee. The trustee must support the best interests of the beneficiaries. The settlor would also be wise to select a successor trustee. The settlor can choose co-trustees with concurrent authority or a successor trustee. A successor trustee becomes the trustee if the trustee can no longer act in that role.

While many settlors create trusts to function after the settlor's death, a living trust differs. The settlor creates a living trust during their lifetime.

Benefits of Living Trusts

There are many benefits to creating a living trust. The primary benefit is that you can avoid probate proceedings that could happen after you pass away. Probate is the distribution of assets through the court system, which can be time-consuming and costly for your heirs.

A living trust allows you to name your beneficiaries and establish a plan for the distribution of assets while you are still alive.

Aside from avoiding probate, another significant benefit of a living trust is privacy. Distributing assets through the probate process could mean that assets and inheritance become part of the public record.

Some complex types of trusts can help save you a significant amount of money in taxes. With an AB Trust, a person leaves money to their surviving spouse. The money goes to their children after that spouse's death. This can provide significant savings in estate taxes.

On the other hand, a revocable living trust is not used for tax benefits. A revocable living trust allows the grantor to maintain control over the trust assets during the grantor's lifetime. Thus, it remains the grantor's taxable property during their lifetime.

Limitations of Living Trusts

The limitations of a trust vary greatly depending on the complexity of the trust. Your experience managing this type of estate planning tool also determines whether it will fit your plan well.

For many living trusts, if you are the settlor, you are also the trustee until you cannot perform that duty yourself. Any assets and properties contained in the trust can be reported on your tax returns. However, any properties outside of the trust must be filed separately.

This additional administrative work may be more than some people want. Managing a trust requires a certain understanding of estate planning and taxes. The complexity increases the longer you act as a trustee of your own trust. But your knowledge may grow over time. A living trust may be an option to consider for your estate plan.

Life Estates

A life estate, often in reference to a property, is the division of an asset between two people. The giver and the receiver(s) (beneficiaries) own the asset simultaneously. A life estate lasts for as long as the life of its creator. A property with a life estate deed cannot be sold without the consent of the creator and the beneficiary.

Many people use a life estate for real estate. The grantor seeks to divide ownership of their homes. A life estate is helpful for many types of property.

Benefits of Life Estates

There are several benefits to creating a life estate. If you are planning your estate and looking for options that can be beneficial during your lifetime, a life estate might be a good choice.

If you are an older individual with adult children, you may choose to establish a life estate for asset protection. Suppose you need to move into a nursing home but need to qualify for Medicaid. Or maybe you need to reduce your assets and qualify for Medicare. With a life estate, you would still hold an interest in the property. The property would not qualify as an asset on your Medicare application.

Upon the grantor's death, the beneficiary receives the property. The property transfer helps avoid probate. The creator of the life estate is also the recipient of any rental income brought in by the property in question.

Limitations of Life Estates

There are limitations if you decide to establish a life estate. For example, you cannot make decisions relating to that property without the beneficiary's consent. If you decide you'd like to sell your property and receive sale proceeds, you may be unable to do so. Whether you can sell the property depends on the beneficiary.

Federal Gift Tax Implications

If you are the beneficiary of a life estate, please note that it is considered a gift by the Internal Revenue Service (IRS). For tax purposes, it's helpful to explore the tax implications of the trust document. Taking this step will allow you to determine how the terms of the trust may impact your tax situation before the life estate goes into effect.

For example, the remainder interest that transfers to the beneficiary may exceed the federal gift tax exemption. In such cases, the grantor must file a gift tax return for the amount. When the value of the remainder interest is below the federal gift tax exemption limit, this tax benefit allows you to avoid a gift tax on the transfer.

Selling Property Subject to a Life Estate

The creator of the life estate and the beneficiaries can agree that the creator can sell the property. The beneficiaries must prepare property taxes on their proportionate proceeds from the sale. It is important to note that the laws regarding taxes applicable to life estates may differ from state to state.

Which Is Best for Your Estate Plan?

It all depends. There is no universal answer for which type of estate plan is best. Every person and family is different. For example, you may form a trust if you have young children or a large group of beneficiaries. You can structure the trust so that a trustee handles the trust administration. A life estate might be your best action if you aim to pass your family home on to your adult child.

Start your estate planning process by identifying your goals. Researching estate law may also help you consider the best estate plan for you and your family.

Before you finalize any plans, speaking with an experienced estate planning attorney or a tax expert is essential. It's wise to seek professional guidance at any step of the planning process.