The main disadvantages to a trust are that it can be costly to establish and somewhat complicated; it can have some ongoing administration needs, and in some ways, it lacks some of the flexibility of other estate planning devices.
Let's look at each one of these issues in turn:
1. High Creation Cost
On average, a trust is more expensive to set up than a simple will. The costs for a simple will can range from $300 to $1,000, depending on the attorney and the complexity of the estate. Meanwhile, setting up trusts can go into the much, much more expensive. For example, a living revocable trust alone can cost anywhere between $1,500 and $3,500, depending on how complex the assets are being transferred into trust and from a legal standpoint. This amount can obviously cost more for an individual whose estates are huge and require minute estate planning .
Not only this, but it is also not just the upfront costs that pose a problem. People who set up trusts are many times bound to engage estate-planning attorneys who can ensure the documents are drawn up correctly, and of course, this would mean another layer of added cost.
Over time, if changes in life circumstances or drastic shifts in assets change, more legal fees will arise to change the original documents. For smaller estates, these may not be large enough costs to warrant creating a trust.
Example:
Think of a family of limited financial means whose only concern is that their kids inherit the family home. A will would be fine for that family and would cost a few hundred dollars at most. To require that such a family establish a trust—either testamentary or living—although it provides added advantages, like avoidance of probate, it's very costly with little value to justify its use for a single major asset.
2. Ongoing Administration Costs
It doesn't mean creating a trust doesn't eliminate any financial burden.
Nearly all trusts carry ongoing administrative charges. Professional trustees are surely going to charge if the one named as trustee is not a family member.
A professional trustee—one for example, a bank or trust company—can be utilized if active management of the estate is required, such as holding investments or real estate or business interests in the trust. Many times this consists of an annual fee charged based on the value of the trust.
Even when the trustee is a family member, professional accountants or lawyers may be required to manage legal and tax filings. It gets even more complicated if there are multiple beneficiaries concerned with the several financial needs associated with the trust. Again, some assets, such as an investment portfolio, require active management on a continuous basis in order for the corpus of the trust to actually serve to increase or maintain its value for the beneficiaries.
Example:
Consider a family trust holding $5 million of assets. A professional trustee may charge 1% per year to manage the trust. This is $50,000 per year in costs. For smaller trusts, this might decimate any value held in trust over time, especially if there are no high returns associated with those assets it holds.
3. Complexity and Difficulty Understanding
Trusts are legal documents or entities that can be quite complex.
Writing a trust requires very specific legal language that most of us don't understand. Many trusts are replete with confusing legal terms and Latin phrases known only to estate law. Although a revocable living trust may range from 30 to 80 pages in length, many different scenarios need to be covered, such as what would happen should the trustee become incapacitated or if the beneficiaries die.
Matters are further complicated by the fact that the complexity goes beyond the document in itself, to the legal requirements that must be followed in maintaining the trust.
As opposed to wills, which take effect upon a person's death, a living trust must be managed during the life of the trustee through diligent record-keeping and reflection of changes in the legal requirements.
These types of trusts are usually designed for a minor child with special needs, and there could be a variety of contingencies envisioned to take place in the future or might happen based on how government benefits or health requirements change. As such, it is usually a long document which is thus quite inconvenient to process without professional intervention.
4. No Estate Tax Savings for Revocable Trusts
Most people think the mere fact that they have created a trust automatically provides tax protection for their estate.
That might be true with respect to certain irrevocable trusts, which, for specific tax purposes, can take property out of the taxable estate, but it certainly is not the case with most revocable living trusts.
It can be a revocable trust in which the trustor retains control over the assets during his lifetime and those assets remain considered his taxable estate.
Where estate taxes are a chief concern, one might use a revocable living trust in concert with other financial strategies: irrevocable trusts, charitable trusts, or gifting strategies such as irrevocable life insurance trusts, 501 charitable trusts, and qualified domestic trusts or spousal lifetime access trusts for same-sex couples.
Example:
A large estate holder puts into place a revocable trust with the goal of managing assets during both life and at death.
However, the estate in question is still liable to pay estate taxes when he or she dies since all the assets he had placed in the revocable trust are still considered part of his overall taxable estate.
Had it been an irrevocable trust, those may not have been treated as part of the taxable estate at all.
5. No Creditor Protection
One of the major disadvantages in using revocable trusts is that they do not shield the trustor's assets from his or her creditors during his or her lifetime.
On the contrary, if irrevocable trusts were made their characteristic advantage over the other would be very well recognized because upon giving certain assets to an irrevocable trust, the trustee is no longer the owner of those assets and all are generally shielded from creditors.
This can be a major setback for those with high liabilities or those who have more tendencies to get sued. Creditors can still reach out and liquidate assets in a revocable trust if the trustor becomes liable for his debts or loses the case in court.
.
Example:
A business owner places property into a revocable trust but is subsequently sued arising out of business liabilities. Inasmuch as the trust is revocable, said assets remain subject to the claims of creditors or judgment holders. By contrast, had those assets been transferred to an irrevocable trust, they may have been shielded.
6. Problems Arising with Real Estate and/or Refinancing
While placing real estate into a trust can help a person avoid probate and make the transition of assets smoother, it does make refinancing a bit more complex. Some mortgage lenders can be gun-shy about lending on property held in a trust, since such an ownership structure can add another level of complexity to the loan process.
This might even include having to take the property out of the trust for a brief period of time, refinancing it in the name of the trustee, and then placing it back in the trust. This will perhaps result in higher legal costs along with delays.
This will mean that in case of refinancing the mortgage, the bank may request the homeowner to take the home out of the trust. Once refinancing has been concluded, then it will be set back into the trust to maintain the estate planning privileges. This will entail avoidable legal and administrative costs.
7. Risk of Going to Court
Even though one of the major benefits to a trust is the bypassing of probate, it does not always evade litigation. Like wills, trusts can be contested.
Beneficiaries can dispute that the trustor did not have the capacity to create the trust, that the trustee mismanaged the assets, or that the terms of the trust are unfair.
The process could also become quite expensive and time-consuming, defeating the original intent for the creation of the trust in the first place. There would also be litigation in cases where the trustee does not act in the best interest of the beneficiaries.
Trustees owe fiduciary duties, which means acting with utmost loyalty and care regarding the management of the trust. In most cases, such duties are breached, and beneficiaries may sue, which is very costly in court.
Example:
In a large family, one sibling names another sibling trustee over a family trust.
Other siblings, who are appointed to the position of trustee due to differences of opinion in the family over how the assets of the trust should be managed, often file suit against the sibling trustee on grounds that he or she is not handling the money appropriately.
Resulting litigation may well produce tens of thousands of dollars in cost and reduce the principal of the trust while causing alienation of family members.
8. No time limits are imposed on creditor claims.
Whereas wills usually provide only a limited period of time within which creditors can file claims against an estate, trusts can potentially remain open to the claims of creditors many years following that trustor's death. Indeed, this is considered one of the major disadvantages of trusts compared with probate, since in the latter, the creditors are usually given a certain time frame within which they must make their claims.
Timescales not applied to such administrative procedures can extend the workability of the trust and hence delay the effective transfer of the assets to the beneficiaries. Besides, delays will extend attorney fees.
Example:
A claim against the trust by a creditor is filed when the trustor has died. If there is uncertainty about the time limit related to creditor claims, it may take several months or even years before resolution of the dispute with the claimant and the actual distribution of his inheritance to the beneficiaries is performed.
9. Complicated Problems Regarding Taxation
Certain trusts, especially irrevocable ones, have a lot of confusing tax problems. For one thing, income that is linked to the trust is normally subject to a higher taxation rate than that of a person's income. In general, there exists a burden in relation to tax reporting.
Trustees may be obligated to file returns annually regarding the trust, and the beneficiaries receiving distributions have to report those distributions as income.
This can also be confusing and more work, especially when there is significant income generated by the trust, either from its investments or from the assets in general.
Example:
For instance, a trust invested in an income-generating portfolio will require the trustee to file suitable tax returns yearly. Beneficiaries to whom such distributions are made will have to declare the same income on their own taxes, which may be a nightmare for a person who could be unfamiliar with such matters.
Conclusion: Weighing the Pros and Cons
While there are many benefits to trusts, including avoiding probate, special needs dependents, and the capability of providing far greater detail regarding control of asset distributions, disadvantages still exist. High setup costs, complex ongoing administration, potential for litigation, and limited creditor protection are all factors that go into your very important decision as to whether a trust is right for you.
Trusts are extremely potent tools, but they aren't the right fit for every situation. Accordingly, one should consult with a qualified estate planning attorney before creating a trust-specific needs that are matched to the appropriate kind of trust.
