Estate planning helps you decide what happens to your assets after you die. You’ll come across terms such as ‘a will’ and ‘a trust’ when you start this process. While you might have heard about both of them before, it’s crucial to understand the differences between the two.
You spend years gathering your assets, and want to ensure you leave them behind to your loved ones. The process is not as simple as stating what you want to happen. There are lots of rules and regulations to consider. Knowing the differences between a will and a trust can help you choose the right tools to manage your estate planning.
What are the main differences between wills and trusts?
You can use a will and a trust as part of your estate planning. They can both give you a say in what happens to your assets. You don’t have to use both of them, but they can work together to ensure you make the most out of your assets.
The main differences between wills and trusts are:
- A will goes into effect after you die while a trust takes effect from the moment you create it
- A trust can distribute your assets before death, at death or afterwards. In contrast, a will always outlines what happens to assets after death
- A will always passes through probate, meaning that a court oversees the administration of the will
- A will becomes part of public records while trusts can remain private
There are other differences to be aware of. It can be easier to understand these differences by looking at the beneficial uses of a will and a trust. Both wills and trusts have unique advantages and disadvantages.
When is it beneficial to use a will?
When it comes to estate planning, most people think about writing a will. A will is a legally enforceable document allowing you to state how you want your affairs handled after death. It must be written, signed and witnessed.
A will allows you to:
- Name your beneficiaries who are those you want to benefit from your possessions and assets
- Select an Executor who is the person managing the distribution of your assets
The main benefit of having a will is the ability to decide how your assets are divided. If you die without it, the courts will distribute your assets and determine your beneficiaries. This could mean your assets end up in the hands of people you don’t want to benefit from your estate.
Until recently, a will couldn’t always protect married couples and civil partners from potential inheritance tax (IHT). The rules changed in 2007, and most couples can now benefit from the ability to transfer unused IHT allowance to each other.
However, the probate means enforcement of your will can be a time-consuming process. A will alone doesn't protect your assets from sideways disinheritance, which is something families with smaller children might need to consider. Sideways inheritance can occur if you leave behind a spouse and children that could expect inheritance in due course. If your spouse remarries and doesn’t make a provision for the children in their will, the estate could go to the new spouse instead.
When can a trust be a better option?
A trust is another tool for estate planning. Like a will, a trust is a legal arrangement. When you create a trust, you appoint a trustee or trustees who are responsible for managing the assets you place into the trust. You can also appoint beneficiaries who are the people benefitting from the assets.
There are many types of trusts. Many of them mean your assets are transferred into the trust while you're still alive. While you always have access to them, you don't own them any longer. When you create a trust, the assets become part of the trust.
You can choose between two main types of trusts:
- A will trust – You set up the trust conditions in your will and the trust only activates after your death.
- A lifetime trust – Often known as property or asset protection trusts and they are established straight away.
Trusts have traditionally helped with tax planning. Will trusts allow couples to split their estate into halves and save on IHT payments. However, as mentioned above, married couples and civil partners can now transfer unused IHT allowance to one another.
Trusts also last a specific time. Most often, parents create trusts to benefit their children. For example, you can put assets into a trust and provide an income for the child until the trust expires. The income generated is subject to tax. However, the tax liability might be less than if the person inherited the whole asset at once upon your death.
Taxation of trusts can be a complicated matter, and it’s not a good idea to approach trusts simply as a tool to reduce tax liability. The taxation of your trust depends a lot on the type of trust you create as well as the assets within it.
Choosing between a will and a trust
Trusts and will have a similar purpose in terms of helping you with estate planning. They are useful tools allowing you to have a say in what happens to your possessions and assets after you die. But as the above shows, they have differences in what you can achieve with them.
Both are useful and could benefit you. Their advantages depend on your situation. Therefore, you should consider the pros and cons of both. With a will, you can provide financial security for your loved ones and help reduce IHT. However, you will go through probate, unlike with a trust. A trust can also reduce the tax burden on your loved ones, although the rules can be complicated.
If you're unsure which option is best for you, consider discussing your situation with a professional. They can help present you with different options. Analysing the possibilities with a professional will make it easier to understand the best option for you.
The most important takeaway is that both a will and a trust will give you a say in what happens to your assets after you die. If you do not have either of these legal documents, then you cannot have certainty on what happens to those assets. To protect your loved ones, it is a good idea to begin estate planning as soon as possible.