The Differences Between Life Estates and Trusts

Life estates and trusts can be useful for:

• Lowering your taxable income and assets during retirement;
• Providing a solid financial future for your loved ones; and
• Easing the transition of your estate after your passing.

Each form of estate planning has its benefits and limitations, but with the right information and the right lawyer, you can decide whether a life estate or a trust is more in line with your goals.

Life Estates

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

Many people use life estates to divide ownership of their homes, but they can be used for many types of property.

Benefits of Life Estates

There are several benefits to the creation of a life estate. If you are planning your estate and looking for options that can show benefits during your lifetime, then a life estate might be a good choice for you.

If you are an older individual with adult children, you may choose to establish a life estate to reduce your assets and qualify for Medicare. You would still hold an interest in the property, but it wouldn't qualify as an asset on your Medicare application.

Upon the death of the giver, the beneficiary receives the property, which 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

If you decide to establish a life estate (with your children as beneficiaries, for example), then you are unable to make decisions on that property without the beneficiary's consent. This means that if you decide you'd like to sell your property, you may be unable to do so — instead, it depends on the opinion of the beneficiary.

If you are the beneficiary of a life estate, please note that it is considered a gift by the Internal Revenue Service. The remainder interest of the property has been transferred to the beneficiary. If this amount exceeds the federal gift exemption, then you will need to file a gift tax return for the amount.

If the creator of the life estate and the beneficiaries agree that the creator can sell the estate, then the beneficiaries should be prepared to pay taxes on their proportionate proceeds from the sale. It is important to note that the laws regarding life estates and the taxes connected to them may differ from state to state.

Living Trusts

A trust involves three different types of people, each of whom plays a unique role in the trust. The settlor is the creator of the trust. They are the original owner of the funds and assets in question, and they decide who will be involved in the management of the trust, as well as who will benefit from it.

The person who is in charge of caring for the assets within the trust is known as the trustee. They must support the best interests of the beneficiary, the person who will benefit from the funds provided for by the trust.

While many trusts are designed to function after the settlor's death, a living trust is different. A living trust is created by the settlor during their lifetime.

Benefits of Living Trusts

There are many benefits to creating a living trust. The primary benefit is that you can avoid the probate proceedings that could happen after you pass away. Probate is the distribution of assets through the court system, which can be both 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. If you go to court, the matter of your assets and inheritance becomes a public record.

Some complex types of trusts can help save you a significant amount of money in taxes. For example, an AB Trust — wherein a person leaves their money to their spouse, and in the event of that spouse's death the money goes to their children — can help save a family hundreds of thousands of dollars in estate taxes.

Limitations of Living Trusts

The limitations of a trust will vary greatly depending on the complexity of the trust that you form and your own experience with managing this kind of legal structure.

For many living trusts, if you are the settlor, you are also the trustee until you are unable to perform that duty for yourself. Any assets and properties contained within the trust can be reported on your tax returns. However, any properties outside of the trust must be filed separately.

This excess in paperwork may cause some confusion if you are not experienced in certain issues surrounding estate planning and estate taxes. The complications can grow the longer you act as a trustee of your own trust.

Which Is Best for Your Assets?

There is no single, universal answer for which type of estate plan is best. Every person and family is different, and therefore they require different types of estate planning. If you have young children or a large group of beneficiaries, you may choose to form a trust that can be monitored and controlled by a trustee who handles trust administration. If you are trying to pass your family home on to your adult child, then a living estate might be your best course of action.

Researching estate laws, talking with experienced lawyers and tax experts, and identifying your goals will help you to create the best estate plan for you and your family.