There are several ways for people to hand down their property to their heirs and/or charitable institutions, depending on their preference and the amount of estate to leave. These most commonly break down into two categories: wills and trusts. In this article, I will briefly discuss some of the most widely used of these.

The most basic of the estate planning tools is a will, which is a document created by someone (a “testator”) before they die to determine how the assets remaining at the time of their death will be distributed.

While there are some variations to the types of wills available, they are all established prior to the testator’s death and go into effect after that person dies. The most common type is the attested will, which must be signed not only by the testator but also by witnesses. Wills can have more than one testator: they can be made jointly, where the assets get left to the other testator, and can’t be changed when one of the testators dies. Other wills that can be jointly established are mirror wills, which are created when two people make identical wills leaving the assets to the surviving person; and mutual wills, which are separate documents signed by both parties. A living will differs from the other types. It goes into effect when the testator is still alive, but has become incapacitated, and can no longer make his/her wishes known. A pour-over will is often made in conjunction with establishing a trust, and allows for the remainder of assets from the will to go into the trust. A testamentary trust will is actually a trust, but unlike a true trust, doesn’t go into effect until the testator dies. Beyond this the greatest variety in wills lies in the form they take, such as oral or video wills.

Assets left through wills have to go through probate, which can take between six and twelve months, if not longer, and can cost approximately between 3% to 8% of the value of the estate’s  assets. To avoid having their estate go through probate, a person (called a “grantor”) can place their assets in one (or more) of a variety of trusts. A trust is created as a separate entity with a trustee and beneficiary, either of whom may or may not be the grantor. Because they are established prior to death, they are not required go through probate.

Trusts can be established as either revocable or irrevocable. With a revocable trust, the grantor can make changes, but will still be taxed on the trust’s asset income. With an irrevocable trust, the grantor can’t make changes to the trust because it becomes a separate entity, but it is also taxed separately from the rest of the grantor’s estate, although beneficiaries may have to pay income tax on any income they receive from the trust’s assets. The beneficiaries can be the grantor’s heirs or organizations or charities of choice. Trusts can also be set up to benefit the grantor, such as annuity trusts, which annually pay a percentage of the asset value at the time the trust was established. Unitrusts, by contrast, annually pay a percentage of the current asset value.

The following are some of the different types of trusts:

• Grantor retained annuity trusts (GRATs) pay an annuity to the grantor for a pre-established time period. When the time is up, whatever remains goes to heirs or a charity.
• Charitable Lead Trusts (CLATs) are established to benefit charities during the grantor’s lifetime, but what’s left at the end of the time period goes to the heirs.
• Charitable Remainder Trusts are the opposite of a CLAT, in that they will give to charities what’s left over after a set time period of giving an annuity to heirs.
• Qualified Terminable Interest Property (QTIP) trusts allow the deceased’s spouse to get income from the assets of the trust during their lifetime. After the surviving spouse dies, the assets go to the designated beneficiaries.
• Retained life estate allows the grantor to leave property to a nonprofit organization, but to remain in the residence for the rest of his or her life.
• Generation-skipping (or dynasty) trusts do not give assets to the immediate heirs, but to the generation (or generations) after that. This eliminates some taxation issues, and allows the beneficiaries, who can be the grantor's children, to still benefit from the income of the trust.

The size of estates may be impacted by two kinds of taxes: inheritance tax, which is required by some states with varying rules and regulations, and estate tax, which is paid to the federal government. An estate tax is valued on the total assets of the estate. Currently the estate tax begins when the value of an estate exceeds $5.1M and is taxed at 35% (through 2012). However, this amount may revert to the previous amount of $1M and a tax rate of 55% in 2013 if Congress doesn’t extend the tax breaks that were established through the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act that went into effect in 2010. To mitigate this taxation, people may receive a “unified credit”, which can be applied against both gift and estate taxes but has a lifetime limit ($1.7M as of 2012, but this may change if the rest of the estate tax rules change).

Researchers may uncover some indications of trusts when they are researching a prospect, such as gift announcements or annual reports from other charities and nonprofits, or SEC filings that may include some of the stockholdings that are part of the assets held by trusts. Indications that a prospect may be implementing an estate plan include age and succession planning for their business.

This brief look at wills and trusts barely scratches the surface of the variety and complexity of estate planning tools available to benefit grantors, their heirs and, hopefully, non profits and charities. It will be interesting to see what changes 2013 will bring to the laws that govern wills and estates and how they are taxed.