ETFs vs. Mutual Funds: Why Investors Who Hate Fees Should Love ETFs

While the mutual fund universe is much larger than that for exchange-traded funds, more and more investors are discovering that they can save huge amounts in both fees and taxes and put more money in their pocket by switching to ETFs.

An ETF is a collection of usually hundreds, or sometimes thousands, of stocks or bonds held in a single fund similar to a mutual fund.  But there are also a number of significant differences between the two.

When Comparing Fees ETFs Come Out Clear Winners

Numerous studies show that over the long term, managed mutual funds cannot beat an index fund, such as an ETF.

For example, according to the SPIVA scorecard, 75% of large cap funds “underperformed” the S&P 500 over five years through Dec. 31, 2020.  Almost 70% underperformed over three years, and 60% over one year.  And this is just the tip of the iceberg, with most other managed mutual funds — both domestic and international — underperforming their applicable index.

This is partly explained by the higher fees of managed mutual funds, which cut into the investor’s return. According to Morningstar, the average expense ratio for a managed mutual fund in 2019 was 0.66%. Compare this to a well-diversified portfolio of ETFs, which can be put together with an average blended fee of 0.09%, according to ETF.com. Try getting a fee that low with mutual funds.

What makes the gap in fees even greater are the invisible transaction costs for trading securities inside a mutual fund. Due to the difficulty in calculating these invisible trading costs, the SEC gives mutual fund companies a pass in disclosing them to the consumer.

But University of California finance professor Roger Edelen and his team gave us a pretty good idea when they analyzed 1,800 mutual funds to determine the average invisible trading costs.  According to their research, these costs averaged 1.44%.  Keep in mind this is “in addition” to the average mutual fund expense ratio of 0.66% mentioned above.

An ETF, on the other hand, is cloning an unmanaged index, which generally has very little trading going on, and therefore these hidden trading costs are little to nothing.

Between the expense ratio and the invisible trading costs of a managed mutual fund, the total average expense is easily over 2% for mutual funds, which is over 20 times more than the typical expense of an ETF.

Tax Savings Are Another Win for ETFs

ETFs can also save the consumer money by avoiding taxable capital gains distributions that are declared by the mutual fund even when the investor has not sold any of their mutual fund shares. Mutual funds are required by law to make capital gains distributions to shareholders. They represent the net gains from the sale of the stock or other investments throughout the year that go on inside the fund.

Keep in mind this capital gain distribution is not a share of the fund’s profit, and you can actually have a taxable capital gains distribution in a year that the mutual fund lost money.

ETFs, on the other hand, do not typically trigger this sort of taxable capital gain distribution.  The only time you have a taxable capital gain is when the investor actually sells his or her shares of the ETF for a profit.

They’re More Nimble Then Mutual Funds, Too

An ETF trades in real time, which means you get the price at the time the trade is placed.  This can be a real advantage for an investor who wants to have better control over their price. However, with a mutual fund no matter what time of the day you place the trade you get the price when the market closes.

A Sticking Point to Consider: The Bid and Ask Elements of ETFs

While ETFs have many attractive advantages, a potential problem to look out for has to do with their bid-ask price structure. The “ask” is the price the investor pays for the ETF and the “bid,” which is normally lower than the asking price, is the price the investor can sell the ETF for. 

Highly traded ETFs have a very narrow spread between the bid and ask price, often as little as a single penny. But a thinly traded ETF can have a much larger spread, which under the wrong circumstances could cause the investor to sell the ETF for as much as 4% or 5% less than they paid for it.

Mutual funds on the other hand, set their prices at the close of the market and investors pay the same price to buy and sell, so this risk is eliminated.

Another Point to Ponder: Premium or Discount

ETFs can trade at a premium or discount to its net asset value, or NAV.  Simply stated, this occurs when it trades at what is usually a slightly higher price or a slightly lower price than the value of the ETF’s underlying holdings.

While most ETFs exhibit very small discounts and premiums, some, especially those that are more thinly traded, can stray further away from the true value of the underlying holdings.  For example, if an investor bought an ETF that was trading at a premium well above its NAV, he or she could be subject to a potential loss if the price of the ETF moved closer to its NAV price and the investor needed to sell.

You never have to deal with this issue on a mutual fund because the shares are always priced at the NAV.

The Bottom Line

In spite of these potential disadvantages, for the cost-conscious investor who plans on holding his investments for a while, ETFs may be one way to reduce their fees, allow for more nimble trading and reduce their taxes compared with their mutual fund cousins.

President, Piershale Financial Group

Mike Piershale, ChFC, is president of Piershale Financial Group in Barrington, Illinois. He works directly with clients on retirement and estate planning, portfolio management and insurance needs.

Source: kiplinger.com

FreeWill Review: Pros & Cons

FreeWill Review: Pros & Cons – SmartAsset

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FreeWill is an online estate planning tool that allows you to create or update a legally binding will in as little as 20 minutes. It offers products such as the ability to document funeral wishes, create a durable financial power of attorney, advance healthcare directives (living wills) and give charitable contributions from your retirement or stock brokerage account. As the company’s name implies, FreeWill’s services are completely free. Funding comes from FreeWill’s partnership with more than 100 nonprofit organizations who sponsor these services. You can access the service online, giving users the ability to change or download their will at any time without needing to create a new one.

If you’d rather have a professional personally help you with your entire estate plan, consider working with a local financial advisor.

FreeWill Overview
Pros
  • Fairly robust service for free
  • Online access – Once you create you can update at any time
Cons
  • No live support
  • Relatively smaller range of products
Best For
  • Cost (free)
  • Charitable giving

FreeWill: Services & Features

For a completely no-cost service, FreeWill’s offerings are fairly robust.

First, it can cover an individual’s most important needs for a last will and testament. The website offers a questionnaire via an easy-to-use interface, asking basic information as well as other pertinent details such as current income, family information and whether users have any children or pets that they’d like to cover in their will.

For users who need to create an advance healthcare directive (also known as a living will), filling out the form will involve answering questions about some personal information, selecting a preferred physician and hospital for end-of-life care as well as selecting an agent or healthcare proxy. Then users can share what they need to about the values they wish to be upheld and other specific instructions, before finalizing with signatures and any further instructions specific to their state.

For a durable financial power of attorney, individuals will need to provide some personal information and also select an agent or agents to make financial decisions for them if they become unable to do so. Then users can choose the powers that any agent(s) will be allowed to exercise, list any specific limitations and provide other important details (i.e. compensation, monitors, guardians, revocation and how documents will be executed).

Additionally, in keeping with its commitment to charitable giving, FreeWill offers individuals ways to give a charitable contribution from a retirement account or a stock brokerage account.

FreeWill: Pricing

FreeWill’s Fee Structure
Membership Tiers
  • $0 / Free for individuals
Extra Features

FreeWill’s pricing model is straightforward, as it is free to use for individuals. As an individual user, you can draft your will, durable financial power of attorney or advanced healthcare directive via the website.

Funding comes from FreeWill’s partnership with more than 100 nonprofit organizations who sponsor these services. Nonprofit organizations can learn more about a range of tools that FreeWill offers – like a Bequest Tool, a Qualified Charitable Distributions (QCD Tool) and a Stock Gifts Tool – in order to make gifts easier for both supporters to give and organizations to receive.

FreeWill: User Support

FreeWill’s website offers a streamlined design that’s fairly easy to use. For a last will and testament, its questionnaire form is divided into parts and users can track their progress so that they know how many sections remain to fill out. For services such as advance healthcare directives and durable financial power of attorney, the site outlines the form sections and the information you’ll need to gather before you begin.

If you’re looking for immediate support from customer support representatives, FreeWill unfortunately does not provide this kind of a feature. It does, however, have a contact page as well as a help center page where users can find the answers to some frequently asked questions addressing troubleshooting and technical issues.

Thanks to insight from experts around the country, FreeWill makes sure that a user’s will complies with each state’s specific legal requirements. Of course, FreeWill makes it clear that it is not a law firm and therefore cannot provide legal advice. If you need to enlist the services of a professional attorney or even a professional financial advisor, you should do so separately.

FreeWill: Online Experience

FreeWill does not have any further mobile or online platforms available through its service, as all the final documents will be available to users once they finalize the questionnaire process on the site. There is no app or other software that a user would need to download. Given the company’s no-cost pricing model, this is probably to be expected.

How Does FreeWill Stack Up?

Comparing FreeWill to Other Services
Service Pricing Features Accessibility
FreeWill
  • $0 / Free for individuals
  • Last will & testament, durable financial power of attorney, advance healthcare directive, charitable contributions
  • No legal services or support
TotalLegal
  • $14.95 – $19.95 for legal documents
  • TotalLegal Plan subscription $89/year or $9.95/month
  • Create documents
  • With subscription: Legal services from attorneys
  • With subscription: Document storage vault service
Tomorrow app
  • Mobile app free for families
  • Free for employees covered by employers who buy Tomorrow Plus plans
  • $39.99/year for Tomorrow Plus plan not through employer
  • Mobile creation of estate planning documents, such as will, trust, healthcare directive, power of attorney
  • App allows users to connect with family members and make decisions together
  • No legal services or support
  • Mobile app

The biggest differences FreeWill has over competitors is its emphasis on charitable giving and its free services as a result of that.

Bottom Line

Overall, FreeWill is an easy-to-use website that helps those who are looking to have an official last will and testament the ability to create a simple one using their online forms. The service – including certain other end-of-life planning forms such as a durable financial power of attorney or a living will – is free to use for individuals, with an emphasis on charitable giving driving the company’s ethos and business model. While 24-hour support or live customer representative or legal support is not available with free will, its website allows users to create an account, begin and have their specific forms in just minutes – and also allows them to log in, update and download forms again at any time.

Estate Planning Tips

  • If you’re seeking more detailed advice instead of or in addition to your own estate planning steps, consider reaching out to a financial professional. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool connects you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors, get started now.
  • Estate planning is all about looking ahead and mapping out your plan as best as possible. If you’re going the DIY route, make sure you’re aware of the possible financial consequences. Read more about the dangers of DIY estate planning and five estate planning mistakes you can’t afford to make.

Photo credit: FreeWill

Nadia Ahmad, CEPF® Nadia Ahmad is a Certified Educator in Personal Finance (CEPF®) and a member of the Society for Advancing Business Editing and Writing (SABEW). Her interest in taxes and grammar makes writing about personal finance a perfect fit! Nadia has spent ten years working as a seasonal income tax assistant, researching federal, state and local tax code and assisting in preparing tax returns. Nadia has a degree in English and American Literature from New York University and has served as an instructor/facilitator for a variety of writing workshops in the NYC area.
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The Potential Financial Silver Lining of the Pandemic

To say the last year has been unprecedented might be the understatement of the century. It is hard to imagine anyone who has not been impacted in some manner, some far more than others, by the pandemic. Personal finances are no exception as the volatility of the past year remains front and center for many despite recent market recovery.

However, something interesting is happening. Many people are doing what their financial professionals have been asking them to do since their first appointment! They are paying closer attention to their current and future finances. In fact, according to our 2021 Allianz Retirement Risk Readiness Study, two-thirds (65%) of those surveyed said they are paying more attention to what they are saving and spending, and nearly six-in-10 (58%) have cut back on their spending.

This is, no doubt, a step in the right direction. But — and there is always a “but”— risk readiness needs to be about much more than saving and spending. Although it’s understandably a good immediate approach, given the current environment, there is more to consider, specifically the long term. It might seem difficult to look at now, but retirement planning still needs to remain top of mind.

One area that is often overlooked in accumulating assets that deserves much more attention is income planning. Income planning is ensuring you have enough funds to support your lifestyle throughout your, and your spouse’s lifetime.  The value of income planning should never be underestimated. Without a written plan, which is regularly updated, your retirement dream is nothing but a work of fiction. However, a few simple steps now will set you up for future success. You’ll be much more confident when you reach the retirement reality and embark upon the next chapter of the story of your life.

Know your retirement risks

Significant events are often the triggers that convince people to take a more proactive approach. The pandemic is no exception. It exposed a whole new level of financial risks many people hadn’t recognized.

While it is fresh, use this same lens and think about risks in retirement: longevity, inflation, market volatility, the list goes on and on. We’re reminded of the day-to-day risks that pop up in retirement, such as increased health care needs and mobility issues. This “discovery” phase may be a painful reality check, but it is Step No. 1 in addressing your future income needs.

Review your expense categories

While it is sometimes difficult to predict your retirement spending, using your current expenses as a baseline is a great way to estimate expense categories. As a general rule, your essential expenses, such as food, clothing, shelter and health care costs, take priority over discretionary and legacy spending and require reliable guaranteed income. After all, you must cover essential expenses regardless of market conditions or other factors.

Identify your income sources

While retirement income can come from a variety of sources, most people immediately think Social Security. It is important to know all of the options when filing for Social Security benefits in order to get the most out of them. However, Social Security alone will not provide a complete source of retirement income.

Uncover any potential income gaps

Which brings me to the next point. If, by factoring in Social Security and pension income (if any) you discover that you don’t have sufficient guaranteed income to cover your essential expenses, you’ve uncovered a retirement income gap. This might be jarring, but it is actually good news, as you now know what needs to be done and can get ahead of the situation now rather than having an unpleasant surprise in retirement.

Develop a tailored solution

Working with your financial adviser, you can create a retirement income plan that could cover your essential expenses as well as potentially enhance your discretionary and legacy income. You will want to figure in things like travel, hobbies and other “fun” expenses in addition to the essentials. Retirement shouldn’t be something that is survived but something that is enjoyed.

If you, indeed, have the dreaded income gap, there are several products, such as annuities, that can help you put in place an additional stream of guaranteed income to help cover your needs. (Remember that guarantees are backed by the issuing insurance company.)

There seems to be light coming at the end of the proverbial tunnel. While it might not be an easy mindset shift, getting back on track now with your long-term financial planning will serve you well in the years ahead. The wake-up call has arrived, so what better time than the present to look ahead to better days.

Vice President, Advanced Markets, Allianz Life

Kelly LaVigne is vice president of advanced markets for Allianz Life Insurance Co., where he is responsible for the development of programs that assist financial professionals in serving clients with retirement, estate planning and tax-related strategies.

Source: kiplinger.com

How Much Does a Living Will Cost?

How Much Does a Living Will Cost? – SmartAsset

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Confronting our health and what might happen to us someday is not an easy task. Even though estate planning is emotionally challenging, it’s a necessary step to protect yourself. Not only that, without any plans, your loved ones might face unnecessary difficulties. Dealing with the assets alone can be a struggle. You wouldn’t want them worrying about making medical decisions on top of that. So, if you want to prepare for the future, it might be the right time to ask, “How much does a living will cost?”

One of the best resources for estate planning, especially end-of-life planning, is a financial advisor.

What is a Living Will?

A living will refers to a legal document that records your medical, long-term and end-of-life care choices. However, it only comes into play when you can no longer communicate your decisions to your doctors or loved ones.

Unfortunately, there are a variety of scenarios that may require a living will. For example, if you have a degenerative disease or sustain major brain trauma, you likely won’t be able to advocate for yourself. To prepare for that, individuals make a living will while still healthy and sound of mind. Some frequently mentioned directions people put in this document include ventilators, medication and resuscitation.

Factors that Impact Living Will Costs

Your estate attorney will take special care to customize your living will to fit your needs. Those specifications, however, and your circumstances can shift the price needed to make the document. Some of the factors that influence the overall cost include:

  • Location – Attorneys that work in urban areas tend to cost more than those based in suburban or urban spaces.
  • Professional Experience – Lawyers and law firms that specialize in estate planning will cost more.
  • Directive Complexity – The larger and more complicated your living will, the more expensive it will be to complete.

How Much Does a Living Will Cost?

When researching which estate planning attorney to work with, you should know the basic payment system they will use. If you know ahead of time, you can prepare accordingly. Lawyers tend to use either one of two ways: flat fees or hourly billing. However, you also have the option of do-it-yourself (DIY) living wills.

DIY Living Wills

You might be considering ways to avoid any high, professional costs in the first place. If so, a DIY living will is a cost-effective method. You can search online or visit certain stores to get a basic, pre-made form. The only actual cost, then, would be the notarizing price, which you can expect to be only around $10 to $15. That is unless you want a more complicated pre-made form or will-making software. In that case, certain websites might begin to charge you, although it will still be a low cost compared to professional help. The software typically runs from $20 to $100.

However, you should also know that writing your own legal documents comes with its complications and some risks. Your state likely has rules regarding the document’s legitimacy that you may not know. Any mistakes you make hoping to save money may end up costing you more in the long run. Also, a basic will drafted by an attorney is comparable in price to the cost of higher-end software. So, you may be financially safer to choose professional guidance.

Flat-Fee Living Wills

Once you start working with an attorney, you’ll find that they typically have one of two payment structures. A flat flee works like how it sounds. Once you decide to work with an estate planner, they will ask for one “flat” payment. The cost of that payment will depend on the factors mentioned above: location, attorney experience and and the number and type of documents needed. You can expect a low range of $300, with the higher prices easily exceeding $1,000.

However, a flat fee can be beneficial despite how shocking that price tag might be. It demands less work on your attorney’s part since they won’t have to keep track of hours and can just focus on the living will’s assembly. Also, you get to relax once the process has started, knowing you’ve done your part.

Hourly Payment Structure Living Wills

An alternative to the flat fee is hourly billing. This format will also heavily depend on the circumstances. Again, lawyers in high-traffic areas will likely charge more. So, if you’re in the city, you’ll probably find hourly rates above $300. Outside that area, it’ll drop to around $150 an hour.

Remember, a firm or lawyer’s experience and your living will’s specializations may also drive up those prices.

Benefits of Hiring an Attorney

While the online world is a convenient one, it may not provide for all your needs. DIY legal documents often cost less than working with a professional, but that’s because they’re not customized. The form comes as is ,and you simply fill it out to the best of your abilities.

Furthermore, the benefit of working with a person is exactly that. You can have a dialogue with your estate planning attorney, which is more direct than typing questions into a search engine. You can ask your attorney any concerns you may have about a living will or other legal documents. Also, the document they may for you will cater to your needs.

The Takeaway

Living wills are an important step for any individual looking into end-of-life medical and financial planning. The more vulnerable you are, the more essential they become too. If you think you might need to include a living will in your future, shop around for your best options to make one. If you have straightforward wishes, a DIY living will might be enough for you. In contrast, it may be worth speaking to a professional estate planning attorney if there are several complications. Either way, as long as you have a legal living will, you can be sure you and your family are cared for.

Estate Planning Tips

  • A key part of estate planning is figuring out how much you will have to live on. That’s where a free, easy-to-use retirement calculator can be invaluable.
  • Consider working with a financial advisor as you do estate planning. The great thing is that finding a financial advisor doesn’t have to be difficult. Using SmartAsset’s financial advisor matching tool, you can connect with professionals in your area. It only takes minutes for you to have the expert help you need, so get started today.

Photo credit: ©iStock.com/GCShutter, ©iStock.com/designer491, ©iStock.com/zimmytws

Ashley Chorpenning Ashley Chorpenning is an experienced financial writer currently serving as an investment and insurance expert at SmartAsset. In addition to being a contributing writer at SmartAsset, she writes for solo entrepreneurs as well as for Fortune 500 companies. Ashley is a finance graduate of the University of Cincinnati. When she isn’t helping people understand their finances, you may find Ashley cage diving with great whites or on safari in South Africa.
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Qualified Domestic Trust (QDOT): Marital Deduction

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Trusts can be a useful tool for estate planning if you’d like to preserve assets for loved ones while minimizing estate taxes. A qualified domestic trust (QDOT) is a specific type of trust that can offer tax benefits for married couples. With a QDOT, a surviving spouse can qualify for the marital deduction on estate taxes for assets included in the trust. This type of arrangement can be particularly helpful when a surviving spouse is not a U.S. citizen. Here’s more on how these trusts work, the benefits and limitations of having one and how to establish a QDOT as part of your estate plan. Estate planning is always done best in consultation with a financial advisor.

Qualified Domestic Trust (QDOT), Explained

A trust is a legal arrangement in which you transfer assets to the control of a trustee. This can be yourself or someone else you name and it’s the trustee’s duty to manage assets in the trust on behalf of the trust’s beneficiaries.

A QDOT is a specific type of trust arrangement that’s designed to benefit married couples, specifically when one spouse is not a U.S. citizen. This type of trust extends the marital tax deduction to non-citizen spouses, who would otherwise not be eligible to claim the deduction on estate taxes.

If you’re married to someone who is not a U.S. citizen, then setting up this type of trust could make sense if you’d like to minimize any tax burden your spouse may assume if you pass away first. A QDOT can essentially create a tax shelter for non-citizen spouses as part of an estate plan.

How a QDOT Works

To understand how a QDOT can benefit a non-citizen spouse, it’s helpful to understand the marital deduction and how that applies to estate taxes. Ordinarily, the Internal Revenue Code allows surviving spouses to claim a 100% marital deduction for estate taxes that may be due on assets they inherit when their spouse passes away. This is a significant tax break, as it enables surviving spouses to assume control of marital assets without getting hit with a sizable tax bill.

When a married couple consists of one spouse who’s a U.S. citizen and one who is not, the marital deduction does not apply. That means a surviving spouse could face substantial estate taxes on any assets they assume control of after their spouse passes away. Creating a QDOT and transferring assets to it with the non-citizen spouse named as beneficiary solves this problem.

Assets held in the trust would go to the surviving non-citizen spouse, allowing them the benefit of using those assets as well as any income they generate. They would pay no estate tax on assets in the trust. The surviving spouse could then pass those assets on to their children or another named beneficiary when they pass away. If applicable, the estate tax would be due on those assets at that time.

Benefits of a QDOT

The main advantage of including a QDOT in your estate plan is to extend tax benefits to your spouse if they’re not a U.S. citizen and don’t plan to apply for citizenship. A surviving spouse would be able to enjoy the marital tax deduction on estate taxes. They’d also be able to receive income distributions from the trust. Those would be subject to income tax but not estate tax. If you have a sizable estate then setting up a QDOT could be worth it to ensure that you’re passing on as much of your wealth as possible to your spouse.

While setting up this type of trust is generally more complicated and expensive than setting up a basic living trust, it may be an easier way to afford tax protections to a non-citizen spouse versus having them pursue citizenship.

Limitations of a QDOT

While there are some advantages to QDOT, there are some potential downsides to keep in mind.

First, it’s important to note that the IRS is specific about how these types of trusts are set up. The trustee must be a U.S. citizen and depending on the amount of assets that are held in the trust, a secondary trustee may be necessary. This trustee must be a U.S. bank.

Once the spouse who created the trust passes away, their executor must make a QDOT election when filing a federal estate tax return. This is necessary to qualify for the marital deduction. The IRS specifies that the estate tax return with the QDOT election must be filed no later than nine months after the individual who created the trust passes away.

Estate tax may be due if a surviving spouse receives principal from the trust, rather than income. There are, however, some exceptions to this rule. For instance, if a surviving spouse is experiencing financial hardship and has no other assets to tap into it may be possible to receive principal from the trust without being required to pay estate tax.

Perhaps most importantly, spouses should be aware that a QDOT only extends to assets held in the trust. If you have other assets you wish to pass on to a surviving spouse who’s not a U.S. citizen, those wouldn’t be eligible for the marital deduction protection offered by a QDOT if they’re not included in the trust.

How to Set Up a QDOT

Setting up a QDOT starts with determining whether it’s something you can benefit from having in the first place. If you’re married to someone who is not a U.S. citizen, then it may be worth meeting with your financial advisor to discuss the pros and cons of including a QDOT in your estate plan. Your advisor can help to assess any potential estate tax consequences associated with passing on wealth to a non-citizen spouse.

If you’ve determined that a QDOT is something you need, the next step is finding an experienced estate planning attorney who can help with setting one up. Creating a QDOT  means understanding which IRS rules apply and that’s something an estate planning attorney or a tax professional can help with.

The Bottom Line

A QDOT could be useful to have if you’re married and you want to minimize tax impacts associated with leaving assets to a non-citizen spouse. The biggest considerations to keep in mind are what assets you’ll transfer to the trust and how those will be managed on behalf of your spouse once you pass away. Again, getting help from a tax professional, estate planning attorney and your financial advisor can make creating this type of trust as smooth a process as possible.

Tips for Estate Planning

  • Consider talking to a financial advisor about the tax implications of passing on assets to a non-citizen spouse and whether it makes sense to have a QDOT. If you don’t have a financial advisor yet, finding one doesn’t have to be difficult. SmartAsset’s financial advisor matching tool makes it easy to connect in just minutes with professional advisors in your local area.  If you’re ready then get started now.
  • Wondering if you have enough to retire? Our free, easy-to-use retirement calculator can give you a good estimate of your annual, post-tax income upon retirement.

Photo credit: ©iStock.com/Robin Skjoldborg, ©iStock.com/courtneyk, ©iStock.com/monkeybusinessimages

Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She’s worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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Getting the Best of Both Worlds from an Irrevocable Trust

The seeming finality of an irrevocable trust can sound scary to a lot of people. The whole idea that you are tying up large pools of your assets in a trust, and then giving control of that trust to someone else just doesn’t sit well with them. However, irrevocable trusts have a little more leeway to retain some control than you might realize.

Before we get into the details, we should talk about the two different types of trusts: revocable and irrevocable. The revocable trust, or living trust, is an agreement between the client (commonly called the settlor, grantor or trustor in the document) and the trustee (usually also the client), until his or her death. The living trust is designed to hold assets that remain fully available to the settlor but are excluded from the public probate process at death. These trusts can be fairly simple or very complex. A simple version may only organize the estate for outright distribution at the settlor’s death. A complex version may include several trusts to shelter the settlor’s assets from estate and generation-skipping taxes using available lifetime exemptions. The trust may hold concentrations in family businesses and real property or administer a family office that will provide essential investment and financial services for future generations. 

All domestic trusts, whether for a small estate (under $500,000) or a massive one (worth billions), are governed by the same trust laws, under one state or another. And the Trustee’s adherence to the formalities of those trust statutes is essential to the success of the estate plan. But the settlor’s power to modify the trust is equally essential, because tax and trust laws change, as do the family’s circumstances, and that flexibility ensures that the trust will provide the benefits intended.

Why Have an Irrevocable Trust?

However, for most tax-related trust strategies to go into effect, a trust must be irrevocable when funded, and an independent trustee must be appointed. Many people are apprehensive about using an irrevocable trust in their estate plan. They fear having an unrelated trustee control the legacy for their children under a document filled with legal terms that defy plain English definition.

So, what does it mean today for a trust — any trust — to be “irrevocable,” and why might that be both good and bad?

The first thing to understand is that a trust must have a trustee: one or more institutions with trust powers or qualified individuals who act as fiduciaries. A fiduciary, as it pertains to trusts, must at a minimum act in good faith, within the scope of the authority granted, and solely in the interests of the trust’s beneficiaries.

In recent years, the trend has been to employ family members in trust committees to manage specific assets, make certain tax elections and/or approve or direct distributions for the beneficiaries. In these cases, the trustee is not the sole fiduciary. In fact, for many complex trusts, the trustee is selected mostly to ensure that the laws of a certain state will control the trust’s taxation and administration while the family exercises trust discretion over investments and distributions.

State Codes Define Many Trust Provisions

The courts in the state where the Trust is created determine just how flexible an “irrevocable trust” can be. Most states have adopted a version of the Uniform Trust Code (UTC), a model legislative act to manage trusts in the state. The adopted version of the trust code in any state includes definitions and default and mandatory terms for trust instruments. 

For our purposes, the UTC provides a definition for the term “revocable”: “As applied to a trust, [revocable] means revocable by the settlor without the consent of the trustee or a person holding an adverse interest” and “unless the terms of a trust expressly provide that the trust is irrevocable, the settlor may revoke or amend the trust.” Therefore, irrevocable means that the settlor may not retain an exclusive power to “revoke or amend the trust.”

But many state trust codes explicitly allow for the modification of a trust by the trustee and beneficiaries, subject to the settlor’s consent, if living, without court approval. Some state laws also allow a person to be appointed who may amend the trust, completely restate the trust, add or remove beneficiaries, and even pour the trust assets over into a completely new trust without the approval of any court, the consent of the settlor, or the agreement of the beneficiaries.

Make a Trust Easy to Change or Not?

There are good reasons that a settlor may want a trust to be easy to amend while he or she is living. As children grow into adulthood, many of the assumptions and expectations that may have determined the original trust’s terms and purposes can change in light of actual life events. But why would the settlor want the trust to be so easily modified by the beneficiaries after his or her death?

Simply put, the settlor might not. Clearly, there are many tax and financial reasons why a power to modify a trust that may last several generations is beneficial. But state trust laws have always included a process for a beneficiary to petition the court with jurisdiction to approve a modification, if necessary, to achieve or preserve an important trust purpose. 

The courts have great experience and legal precedent to follow when balancing the preservation of the grantor’s intent — sometimes described as a material purpose of the trust — and elevating the interests of the beneficiaries, which may be contradictory or incongruent. And the court’s power to modify or revoke the trust and distribute the assets outright among the beneficiaries is subject to review by courts of appeal. This system is designed to protect the rights of all parties to the trust, including the deceased settlor, who speaks primarily through the trust instrument itself.

The trend toward ceding greater control to the trust beneficiaries and avoiding the use of state courts may be based on several factors. One is likely rooted in a distrust of the formal judicial system. This distrust may be based on anecdotes describing incompetence, unjustified delay, high legal costs, and unfair or insufficient court orders. This distrust does not stop at the courts but includes institutional trustees, too — primarily because they diligently follow the terms and limitations of the trust instrument, much to the chagrin of beneficiaries who resent the controls authorized by the settlor.

The second factor is that settlors and beneficiaries today are more likely to view the trust relationship as a purely financial strategy to reduce taxes and provide a means for family governance. This perspective does not value fiduciary expertise and services as much as it values family control and discretion.

Getting the Best of Both Worlds with Your Trust

For most settlors, the modern trust laws are a vast improvement, which is why states are trending toward adoption of a uniform trust code that supports almost unlimited beneficiary control, when the settlor consents to such control.

 But what if the settlor wants the best of both worlds: the flexibility and control inherent in the use of family members as fiduciaries who can modify the trust and the protection of the settlor’s intent, evidenced by explicit and enumerated limitations that cannot be modified?

Well, that is the newest discussion point in the trust profession: How to draft an irrevocable trust that includes certain specific, unalterable instructions while giving authority to family members, as beneficiaries, to modify the rest of the trust as needed when laws and circumstances change. 

Most of the rules in the modern UTC are simply default rules that may be excluded or modified by the settlor in the trust instrument. The UTC provides definitions and enumerated powers, duties and standards that allow the trust instrument to incorporate well-understood conventions and context, so the settlor need not execute a hundred-page trust document. But the settlor can pick and choose among the UTC provisions, not including certain mandatory rules essential to public policy and the purpose of trusts under state law.

Likewise, the settlor may provide that certain terms and limitations cannot be modified, even if the trust is poured over, decanted to a new trust instrument. The settlor could require court approval for certain trust modifications or trust termination to ensure that the settlor’s intent is not frustrated. These provisions would essentially opt out of the parts of the UTC that allow the beneficiaries to modify those trust terms and even include a penalty for any attempt. 

An Example of How It Could Work

For instance, a settlor may want the trust to never develop a family farm transferred to the trust, now a family retreat. The trust may include a provision that the farm must be subject to a conservation easement with dedicated funding and supervision. But it may allow the beneficiaries to approve the partition of certain acreage for a limited number of homes for their use, or to sell off some or all the land, subject to that easement, after a specified term of years has passed. 

A settlor would be advised not to limit an appointed trust protector from modifying the trust to, for instance, preserve assets from increased taxation or waste, to add new protections from creditors, or to shelter trust assets for supplemental needs so a beneficiary may qualify for useful public entitlement programs, among other circumstances that may arise.

In fact, no settlor in 1970 would have imagined the economy we have today with the marked decrease in full-time employment with benefits, historically low income tax rates, consistently low inflation, almost zero depository and federal bond yields, the elimination of defined-benefit pension plans, online investment brokerage, and the creation of cryptocurrency, among many other developments.

But a settlor today is making gifts to a trust for their grandchildren, intending to meet the financial needs of a group of preteens to last through their retirement. He or she may want to limit their ability to modify some terms of the trust but should take care not to hobble the trust for lack of flexibility.

Senior Vice President, Argent Trust Company

Timothy Barrett is a senior vice president and trust counsel with Argent Trust Company. Timothy is a graduate of the Louis D. Brandeis School of Law, 2016 Bingham Fellow, a board member of the Metro Louisville Estate Planning Council, and is a member of the Louisville, Kentucky and Indiana Bar Associations, and the University of Kentucky Estate Planning Institute Program Planning Committee.

Source: kiplinger.com

Living Will vs. DNR: Key Differences

Living Will vs. DNR: Key Differences – SmartAsset

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When planning for the future, it’s common to think of what you’ll do with your estate and assets. However, there is more to consider than just your financial situation. You have to take into account your health and well-being, too. That’s where advance medical directives come in. By drafting one, you can ensure you and your body are well taken care of even when you can’t. There are two common ways to employ a medical directive: a living will and do-not-resuscitate (DNR) orders. A financial advisor can help you sort through the pros and cons of both options.

A Living Will Explained

A living will is a legal document that dictates your personally approved medical decisions for future, long-term and end-of-life care. It records your wishes as instructions for your doctors to follow in the case that you can’t communicate them. So, this only comes into play when you’re incapacitated. That can result from a degenerative disease you may have, such as Alzheimer’s, which is terminal. Or, it could be necessary in case you suffer severe brain trauma. Either way, the living will preserves your wishes for how you want to handle those scenarios.

Often, a person will use the document to approve or disapprove life-sustaining procedures. This can include measures like breathing tubes, medication intake and dialysis.

You draft the living will while you’re still sound of mind and body. As long as you’re mentally fit, you can change or revoke the document at any time. However, they’re often made in combination with a power of attorney for healthcare. This is an individual who you choose to make medical-related decisions on your behalf. If you want to change your living will, you should inform your POA for healthcare.

Do-Not-Resuscitate Order Explained

Although you may see a DNR floating in the same conversations as a living will, they are not the same. A DNR is essentially a medical document that tells your doctors what to do if your heart or breathing stops. In this case, it asks the medical professionals not to revive you using cardiopulmonary resuscitation. A DNR is usually only for the chronically ill, frail and elderly. This is because of two main reasons.

The first is that resuscitation can be physically traumatic and even lead to broken ribs or punctured lungs – damage that is difficult for certain groups. The second reason is that resuscitation may require medical intervention the patient otherwise did not want. Moreover, a natural death can be easier to accept.

Living Will vs. DNR: Key Differences

It’s vital to know the difference between a living will and a DNR as you do your estate planning. This is even more important for aging and ill individuals or those considering their estate plans.

So, to review, a living will and a DNR are two different documents. The former is a legal document, while the latter is a medical one. Their main similarity is that they both provide instructions for your doctors and loved ones to follow when you can’t properly communicate. A living will provides an outline of medical procedures that you either do or do not want. Also, it usually involves life-sustaining treatment and end-of-life care, which is more complex than a DNR. In contrast, a DNR focuses on a single medical procedure and typically does not require a living will, although a DNR can be included in the other.

Living Will vs. DNR: Which One Do You Need?

If all you want or require is a DNR or a do-not-intubate (DNI), you only need a DNR. You do not have to pursue a living will as well. However, if you have certain pre-existing conditions or have complicated desires for your future medical care, a living will is valuable insurance. It will protect your wishes when you are not in the position to do so. On top of that, a living will can support spiritual, religious, or otherwise personal medical decisions as well.

The Takeaway

While estate planning comes with its difficulties, it’s better to face it head-on. When you decide if you need a DNR or living will, you take a weight off of your and your family’s shoulders. Since medical and end-of-life care is so personal, you avoid family stress and upset by making the decision ahead of time. If you think either option might be right for you, discuss your choices with your family and doctor. Keep in mind that another option is what’s called a medical order for life-sustaining treatment. You can also speak with an estate planning attorney to discuss your living will options.

Tips for Estate Planning

  • Income in America is taxed by the federal government, most state governments and many local governments. The federal income tax system is progressive, so the rate of taxation increases as income increases. A federal income tax calculator can give you a quick read on what you owe Uncle Sam.
  • Consider working with a financial advisor as you do your estate planning. Finding one doesn’t have to be hard. With SmartAsset’s financial advisor match-up tool, you can get connected with local, experienced advisors in minutes. If you’re ready for the help you deserve, get started now.

Photo credit: ©iStock.com/kupicoo, ©iStock.com/svetikd, ©iStock.com/courtneyk

Ashley Chorpenning Ashley Chorpenning is an experienced financial writer currently serving as an investment and insurance expert at SmartAsset. In addition to being a contributing writer at SmartAsset, she writes for solo entrepreneurs as well as for Fortune 500 companies. Ashley is a finance graduate of the University of Cincinnati. When she isn’t helping people understand their finances, you may find Ashley cage diving with great whites or on safari in South Africa.
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Source: smartasset.com