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Trusts and estates are the two main legal structures for transferring assets to your heirs and beneficiaries. Each works in critically different ways. Estates make a one-time transfer of your assets after death. Trusts, meanwhile, allow you to create an ongoing transfer of assets both before and after death. Here’s how each one works. Consider working with a financial advisor as you weigh the relative merits of trusts and estates.

What Is an Estate?

An estate is everything that you own when you die. This does not include anything held jointly with someone else. Nor does it include anything that you have transferred or otherwise assigned by the time you die. Your heirs include anyone who receives money, belongings or other assets from the estate.

So, for example, say Steve dies. The house that Steve and his wife owned together doesn’t become part of his estate, as it now belongs solely to his wife. Nor would anything that Steve gave away as his death was approaching. Instead, Steve’s estate would include anything that Steve independently owned at the time of his death.

An estate is temporary. It exists to make a one-time distribution of the assets of the deceased. Once those assets have been disposed of, the estate no longer exists. This does not mean, however, that an estate is necessarily short-lived. Some estates can last for years, if that’s how long it takes to make a final distribution of all assets.

An estate can be distributed in two main ways: by will or by legal chain of inheritance.

A will is a series of instructions for who should get the assets of an estate and how those assets should be distributed. If the decedent (a legal term for person who died) has a valid will at the time of death, the estate is distributed under those terms.

When someone dies without a will, this is known as dying intestate. In this case their assets will be distributed according to state law. Most of the time this means that the decedent’s assets go directly to their next of kin. In most states, spouses claim priority in this line of inheritance, followed by children, then parents and then extended family.

One of the most common misunderstandings regarding an estate is how much control someone has over the terms of his or her will. While state law governs who inherits when someone dies intestate, most states have very few restrictions on how someone can distribute assets through a will. When you die, you are mostly free to leave your belongings to whoever you choose.

Before anyone can inherit, however, an estate has to resolve three main obligations:

  • Existing debts;
  • Estate taxes;
  • Costs, fines and fees.

When someone dies, creditors and bill collectors have first claim on the assets of the estate. The estate pays all debts owed by the dead person before anyone else can inherit. This can involve selling off property, if the deceased didn’t have enough cash to pay bills. If those bills are larger than the estate itself, the heirs receive nothing.

In addition, when someone is wealthy enough, the person’s estate can trigger dedicated estate taxes.

Estate taxes are assessed based on how much an heir has received, and they require a high level of wealth. In general, for an individual, estate taxes do not apply unless you have inherited more than $11.18 million ($22.36 million for a couple filing jointly). This includes not only cash but also the value of any property or other assets. (For example, if you inherit land worth $30 million you will owe estate taxes on that inheritance.)

If estate taxes apply, they are paid out of the estate itself.

Finally, some estates require oversight and management. Any related costs and fees are drawn directly from the estate itself.

An estate can trigger any number of different potential costs. For example if the terms of a will are overseen by a lawyer, that attorney will bill his or her legal fees directly to the estate. If an estate requires management, someone may be named its executor. This is someone whose job it is to distribute assets according to the will’s instructions, pay any bills, and otherwise manage the distribution of assets. Depending on the workload, the executor may bill the estate for his or her time. Or, if an estate is large or complex enough, a probate court judge may oversee the distribution of assets. Court costs and fees are drawn from the estate.

In other words, any costs related to the management of the estate are paid by the estate itself.

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