What Are the Disadvantages of a Trust?

Trusts represent what can be an invaluable tool for managing personal and familial wealth. There are specific uses, drawbacks and benefits of trusts, but it’s important to understand what your specific purpose is before using one. The ability to have a degree of control over your assets, even after death or a potential reduction in tax liabilities are a few compelling reasons. While we will provide guidance in this article, the advice of a financial advisor that is applied to your personal situation can be invaluable when navigating complex tools like trusts.

What Trusts Are Used For

Trusts, in their simplest form, are fiduciary arrangements that enable a third party, aptly named the trustee, to manage assets on behalf of one or more beneficiaries. This complex legal framework primarily serves three functions: estate planning, wealth protection and tax planning.

In estate planning, trusts help manage wealth distribution after the grantor’s death, ensuring their assets are allocated according to their wishes. For example, a trust can prevent a minor child from receiving a large sum of money all at once or specifying funds for specific purposes such as education or healthcare.

They also provide an effective means for wealth protection, safeguarding assets from potential threats, such as lawsuits or creditors. It protects everything that you would like to pass on to your children or other beneficiaries without others being able to stake a claim to your assets.

Lastly, trusts can be potent tools for tax planning, helping to minimize tax liabilities while maximizing wealth for beneficiaries. For example, the right trust setup can help you avoid estate taxes or ensure assets are not subject to probate.

A financial advisor can further guide you in understanding how the different uses of trusts may apply to your own unique circumstance.

Disadvantages of Opening a Trust

A financial advisor explaining the disadvantages of using a trust for estate planning.

Despite their benefits, opening a trust comes with its own set of challenges. Trusts often require substantial initial and ongoing costs and can be difficult to maintain. Let’s take a look at the biggest disadvantages, or cons, to using a trust in your estate planning.

Setup Fees: The initial setup of a trust can range from $1,000 to $3,000 or even more, depending on its complexity and attorney’s fees. Furthermore, there are recurring administrative costs such as trustee fees, tax preparation fees, and legal fees.
Ongoing Record-Keeping: Trusts also require meticulous record-keeping and can be complex to understand and manage. There is a strict legal framework that must be adhered to, which can be daunting for many.
Your Assets Might Not Be Protected: Another crucial point to note is that not all trusts offer protection from creditors. For instance, in revocable trusts, the assets are not protected from creditors as the grantor retains control of the assets.
Potential Tax Burdens: Finally, trusts can carry potential tax burdens. Trusts may be subject to a higher income tax rate than individual taxpayers in certain scenarios.

Types of Trusts

Trusts come in various forms, each with its own set of rules and benefits. Here are some of the most common that you should be aware of:

Revocable trusts can be altered or canceled by the grantor during their lifetime, making them a flexible option for those who may change their minds about how their assets should be distributed.
Irrevocable trusts cannot be changed or terminated without the beneficiary’s permission. These are great for those aiming to minimize estate taxes, as their assets are not included in the taxable estate.
Testamentary trusts are created by a will and come into existence after the grantor’s death. These are ideal for those who want to control how their estate is distributed after their demise.
Living trusts are established during the grantor’s life and can be either revocable or irrevocable. These offer a way to ensure avoid probate.
Charitable trusts are set up to benefit a particular charity or the general public. If philanthropy holds a specific place in your heart, it can provide you with immediate tax benefits.

You may want to carefully analyze each type of trust or ask a professional before deciding which one is going to best help you achieve your goals.

How to Choose a Trust for Your Needs

The right trust depends on your financial goals, family situation and how much control you want over your assets. A revocable trust, for example, can be a good choice if you want flexibility, as it lets you change beneficiaries, add or remove assets, and update terms as needed. But, if your priority is to protect assets from creditors and reduce taxes, an irrevocable trust could be better option since it removes assets from your taxable estate and offers stronger legal protection.

If you need to provide ongoing financial support for loved ones, testamentary trusts and special needs trusts can help. A testamentary trust, created through a will, controls how and when assets are distributed, which is useful for minors or dependents who may not be ready to manage money. A special needs trust can offer financial support for a person with disabilities without affecting their eligibility for government benefits. And, if you want to donate to charity, another option could be a charitable trust, which can direct funds to a cause while providing tax benefits.

Each trust serves a specific purpose, so you should consider your needs before choosing one. Think about taxes, management responsibilities and how soon your beneficiaries will need access to funds. Talking to an estate planning attorney or financial advisor can help you pick the best trust for your situation.

Common Mistakes When Setting Up a Trust

One of the most common mistakes when creating a trust is failing to properly fund it. A trust only works if assets are legally transferred into it, yet many people forget to retitle bank accounts, real estate, or investments in the trust’s name. Without proper funding, assets may still go through probate, defeating one of the main benefits of having a trust. To avoid this mistake, review all assets so that they are correctly titled or designated to the trust.

Another mistake is choosing the wrong trustee. The trustee is responsible for managing trust assets and making distributions according to your instructions. Selecting someone who lacks financial or legal knowledge can lead to poor management, delays, or even legal disputes. Therefore, you should choose a responsible, financially savvy person or a professional trustee who can handle the role effectively. Consider discussing responsibilities with your chosen trustee to confirm that they are willing and capable.

Lastly, many people fail to update their trust over time. Major life events such as marriage, divorce, the birth of a child, or significant financial changes could require adjustments to beneficiaries or asset distributions. Without updates, a trust may no longer reflect your wishes or provide for your intended heirs. Regularly reviewing and updating your trust will help keep it aligned with your current goals and family situation.

Bottom Line

A couple deciding if the disadvantages of a trust are okay to still use one.

Deciding whether to open a trust largely depends on your personal situation. A family with a large estate and complex needs could find substantial benefits in a trust. However, for a single individual with a simple estate, the costs and complexity of a trust may not be justified. It’s essential to seek professional advice when considering such a significant financial decision. The potential implications of opening a trust on your financial future are not a decision to be taken lightly.

Tips for Estate Planning

The right estate plan will take into account the full range of your financial situation. You’ll want to make sure nothing is forgotten and that you have your assets protected. A financial advisor can help you do just that and make sure your specific needs are met. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
When you’re looking at your choices for creating an estate plan, it’s important to make sure that you’ve completed all the right things. Try using SmartAsset’s estate planning checklist to see how much you’ve completed.