Wills vs. trusts: what each one does

Wills and trusts are the two documents most people think of when they hear "estate planning." Both say who receives property after a death. They work in different ways, take effect at different times and cover different things, and many households end up using both. This post explains what each one does and where each one stops.

What a will does

A will is a written set of instructions that takes effect at death. In general terms, a will:

• names who receives the property that passes under it,
• names an executor to carry out those instructions, and
• may nominate a guardian for minor children.

The IRS explains that an executor is generally named in a will to administer the estate and distribute property as the person directed. If there is no will, or the named executor cannot serve, a court usually appoints an administrator who does the same job.

A will does nothing while the person is alive. It also does not operate on its own after death. It is carried out through probate, the court-supervised process in which someone is given authority to collect assets, pay debts and distribute what is left. Having a will does not avoid probate. It tells the court what the person wanted.

What a trust does

The IRS describes a trust as a relationship among three roles created under state law:

• the grantor (also called settlor or trustor), who creates the trust and usually contributes the property,
• the trustee, who holds legal title to the property and manages it under the trust's terms, and
• the beneficiaries, who are entitled to benefit from it.

The type most often used in household estate planning is the revocable living trust. "Living" means it is set up during life. "Revocable" means the grantor can change or cancel it. According to the Consumer Financial Protection Bureau, the grantor typically serves as their own trustee and keeps using the property, and a successor trustee steps in if the grantor dies or can no longer manage things.

An irrevocable trust, by contrast, generally cannot be modified or revoked once it is created. It serves more specialized purposes and is a separate subject.

How the two differ

The CFPB lists avoiding probate as one reason people set up a living trust, noting that probate is a public process and can be expensive and lengthy. How expensive and how lengthy depends heavily on the state and on the estate, so the weight of that advantage is not the same everywhere.

The funding step

A trust controls only what it owns. The CFPB puts it directly: a living trust is ineffective until the person who makes it puts money or property into it. That means retitling assets, such as a house or a bank account, in the name of the trust.

This is where trusts often fall short in practice. A signed trust with nothing transferred into it does not keep anything out of probate. For that reason a trust is commonly paired with a short will, sometimes called a pour-over will, that directs anything left outside the trust into it at death. Property caught by that will generally still goes through probate first.

What neither document controls

Some assets pass by their own terms and are not governed by a will or, unless the trust is named, by a trust:

• Retirement accounts and life insurance go to whoever is named on the beneficiary designation.
• Jointly owned accounts held with rights of survivorship generally pass to the surviving owner.

Neither document is a substitute for a power of attorney or health care directive either. A will has no effect during life, and a successor trustee has authority only over what is in the trust.

Taxes: a common misunderstanding

A revocable living trust is sometimes assumed to lower taxes. In general it does not. The IRS states that all revocable trusts are grantor trusts: the grantor is treated as the owner of the assets, the trust is disregarded as a separate tax entity, and the income is taxed to the grantor. Because the grantor keeps control, property in a revocable trust is also generally still counted as part of the estate for federal estate tax purposes.

Questions worth asking

People weighing the two often consider:

• How much of what they own would actually pass under a will, once beneficiary forms and joint ownership are accounted for?
• Is there property in more than one state, minor children, or a family situation where privacy or continuity matters?
• Who would serve as executor or successor trustee, and is that person willing? Either role is a fiduciary one. The CFPB publishes plain-language guides for people asked to manage someone else's money.
• If a trust is created, who will see that assets are moved into it?

The requirements for a valid will or trust are set by each state and differ in their details, so an estate planning attorney can advise on what a particular situation calls for.