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By Christine Benz | 10-06-2014 10:00 AM

Do You Need A Trust?

Estate-planning expert Deborah Jacobs shares her guidelines for determining whether a trust is right for you.

Note: This video is part of Morningstar's October 2014 5 Keys to Retirement Investing special report.

Christine Benz: Hi, I'm Christine Benz for What is a trust and do you need one? Joining me to discuss that topic is estate-planning expert Deborah Jacobs.

Deborah, thank you so much for being here.

Deborah Jacobs: Thank you for having me.

Benz: Deborah, a lot of people hear the term trust and they think maybe they need one. Let's talk about the basic need for a trust--what trusts do--and then we'll get into who might actually need and benefit from a trust.

Jacobs: Maybe first we should talk about how trusts work. There are many people who are reluctant to admit that they really don't understand what these things are. So, I like to explain that a trust is an invisible legal wrapper created by a document that looks a lot like a contract. Title to the assets passes to someone called the trustee, who manages the assets and then gives them out according to the wording of the trust document.

Benz: So, that's the basic framework for trusts. What are some of the most commonly used trusts? And when people are thinking about their retirement plan and how it intersects with their estate plan, what are the trusts that will tend to be the most common and the most helpful for people to contemplate?

Jacobs: The one that is most commonly used and most helpful for planning for later in life is what's called the living trust. This is a trust that can serve two purposes: one is to pass assets after you die, but it also takes effect while you are alive to hold assets for your benefit--for example, in the case of dementia. Previously, before the estate tax exemption amount went up to now more than $5 million, people used to use trusts. A very garden-variety trust was the life insurance trust, which would buy the policy and hold it for the benefit of beneficiaries, so that when the proceeds were paid out, they would not be considered part of the estate of the person who was insured under that policy. Those trusts, although many of them are still in existence from life insurance policies that were bought in the past, will no longer be necessary for many people and they are somewhat cumbersome to run.

Benz: Backing up to the idea of living trusts, Deborah, you mentioned that they can be helpful in case of dementia, say, which is an increasing problem in the elderly population. Let's talk about how such a trust would interact with the power of attorney that someone might have--that durable power of attorney. On the surface, it might seem that those two things would serve the same goal.

Jacobs: Well, first of all, a living trust only applies to assets that you put into the trust. So, you still might want to have a durable power of attorney for anything that you have neglected to put into the trust. The other thing is that some financial institutions would much rather you have a living trust then a durable power of attorney. And another thing to consider is that if you owned real estate in more than one state, real estate is subject to probate--that is, court oversight of the distribution process after you die. So, it is subject to probate in the state in which it's located. So, if you have a home in New York and you also have a home in Massachusetts, for example, ordinarily your estate would need to be probated in both of those states; however, if you put one or both of your homes into the living trust, that would avoid the need for probate in two states in that way. So, that's another really important reason that people might want to consider having a living trust.

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