A trust is a valuable tool to protect assets, support loved ones, and bypass probate. However, poor planning and misunderstandings often lead to costly mistakes. Knowing these risks helps ensure your trust functions as intended.
1. Failing to Fund the Trust
A trust is only effective if it holds assets. Many people create a trust but fail to transfer their assets into it, rendering it useless.
Mistake: Not funding the trust with real estate, bank accounts, or investment assets leads to these assets still being subject to probate.
How to Avoid This Mistake:
- Make sure titled assets are title in the name of the trust.
- Work with an attorney to ensure all intended assets are correctly transferred.
- Regularly update and review your trust to ensure all assets are included.
Real estate is a common asset to include in a trust. Here’s a quick overview of how real estate is typically added into a trust:
2. Choosing the Wrong Type of Trust
Trusts come in multiple forms, each serving a different purpose. The two most common categories are:
- Revocable Living Trusts – Allow the grantor to modify or dissolve the trust during his or her lifetime.
- Irrevocable Trusts – Generally cannot be changed once established, but can offer greater asset protection and tax benefits.
Within these categories, there are many sub-categories. There are generation skipping trusts, asset protection trusts, special needs trusts, life insurance trusts, and many others.
Some of them are more effective for flexible planning, while others are geared more towards asset protection and tax planning.
Depending on a your goals, one type of trust might be much more effective than another.
Mistake: Many people choose the wrong type of trust based on incorrect assumptions.
How to Avoid This Mistake:
- Determine your goals before creating a trust (e.g., avoiding probate, asset protection, tax benefits, etc.).
- Consult with an estate planning attorney to choose the right trust for your needs.
- Understand the differences between revocable and irrevocable trusts before making a decision.
3. Naming the Wrong Trustee
Your trustee is responsible for managing and distributing assets according to your wishes. Many people name a close family member without considering whether that person is financially responsible or knowledgeable enough to handle the role.
Mistake: Appointing a trustee based solely on personal relationships without considering their capability can lead to mismanagement or conflicts of interest.
How to Avoid This Mistake:
- Choose someone trustworthy, financially responsible, and capable of managing legal responsibilities.
- Consider appointing a professional trustee, especially if your estate is complex.
- Name a backup trustee in case the first choice is unable or unwilling to serve.
4. Not Updating the Trust Plan Over Time
Life circumstances change, and so should your trust. If you create a trust-based estate plan and never update it, outdated provisions may not reflect your current wishes or legal requirements.
Mistake: Many people create a trust and never update it, leading to outdated provisions that no longer reflect their wishes or current laws.
How to Avoid This Mistake:
- Review your trust plan documents periodically and after major life events (e.g., marriage, divorce, birth of a child, death of a beneficiary, etc.).
- Make changes as needed with the help of an attorney to keep your trust legally valid.
- Ensure your trust aligns with current state laws and tax regulations.
5. Forgetting to Name Beneficiaries Properly
Improperly naming beneficiaries or failing to update them can create confusion and legal challenges. Some people fail to provide clear instructions, leading to disputes among heirs.
How to Avoid This Mistake:
- Clearly name all beneficiaries and specify how assets should be distributed.
- Avoid using vague terms like “my family” without defining who qualifies.
- Review and update beneficiary designations regularly.
6. Ignoring Tax Implications
Trusts can have significant tax consequences. Depending on the situation, a trust can avoid unnecessary tax burdens for beneficiaries.
Mistake: Setting up a trust without considering potential estate taxes, income taxes, or capital gains taxes that could impact beneficiaries.
How to Avoid This Mistake:
- Consult with an estate planning attorney or tax professional to understand tax implications.
- Choose the right type of trust based on your financial situation.
- Consider options like charitable trusts or irrevocable life insurance trusts for tax benefits.
7. Not Considering Creditors and Lawsuits
Some trusts do not offer any significant protection from creditors or lawsuits. Trusts are not a magic pill for providing automatic protection – they need to be set up and managed properly to offer comprehensive asset protection, and it might now always be a viable option.
How to Avoid This Mistake:
- Use the right kind of trust for asset protection if necessary.
- Work with an estate planning attorney to draft the trust documents for maximum asset protection.
- Manage the trust in a way that allows for effective asset protection if that is your goal.
8. Assuming a Will is Enough
Many people think a will and a trust serve the same purpose. While a will provides instructions for distributing assets after death, it generally does not avoid probate or protect assets like a trust can.
Most effective trust plans will still include a will. This will is typically a backup to the trust (often called a “pour over will”) which states that any assets left outside of the trust at your passing are directed to go into the trust.
How to Avoid This Mistake:
- Understand that a trust and a will serve different but complementary roles.
- Use a trust to manage assets during your lifetime and after your death.
- Have both a valid will and trust to cover all estate planning needs.
9. Creating a Trust Without Legal Guidance
Do it yourself estate planning can lead to costly errors. Many online trust templates do not comply with individual state laws, or do not provide the type of necessary customization, which may cause issues later.
Plus, many of these online templates do not explain how the trust is supposed to be managed after formation. Initially forming the trust is only one part of the process.!
How to Avoid This Mistake:
- Consult with an estate planning attorney.
- Avoid generic forms that may not be legally valid in your state.
- Ensure your trust document is properly executed and follows state requirements.
10. Failing to Consider Special Needs Beneficiaries
If you have a beneficiary with disabilities, leaving them an inheritance through a regular trust or will could disqualify them from receiving government benefits like Medicaid or Supplemental Security Income (SSI).
How to Avoid This Mistake:
- Set up a properly-structured special needs trust to protect eligibility for government assistance.
- Work with an attorney experienced in special needs planning.
- Ensure the trust is properly funded and structured to benefit the individual without disqualifying them from aid.
Final Thoughts
Setting up a trust is an excellent way to ensure your wishes are followed and to potentially protect your assets.
However, making mistakes in the process can lead to legal headaches, unnecessary taxes, and conflicts among beneficiaries.
If you are considering setting up a trust, it’s always best to work with a knowledgeable estate planning attorney to ensure that your trust is legally valid and meets your specific needs.
At Duffley Law, we specialize in estate planning and can guide you through the process of preparing an estate plan that suits your needs and helping ensure that it works as intended.