There are several ways to handle your estate. Intestacy -- dying without a will -- is an option for some people with relatively simple finances. For others, a will can be a useful tool to take care of giving away your goodies -- but it can open up the can of worms known as probate.

A simple will, a health-care proxy and durable power of attorney, and updated beneficiary designations are often all you need to carry out your final financial wishes with ease. However, a living trust -- a single document that combines the provisions of a will and a financial power of attorney -- can offer additional asset-management muscle both while you're alive and long after you're gone.

Before you add this $3,000-plus document to your filing cabinet, read on.

Trust as a tax dodge? Not really
Plenty of companies pitch living trusts as immediate tax havens or magical IRS inheritance workarounds. Neither is the case. Such misguided advice can leave your heirs mourning the legal mess you've left them to mop up.

Let's set the record straight: A living trust does not inherently steer your loved ones away from estate-tax sinkholes. You (while you're alive) and your heirs (when you're out of the picture) will still pay taxes on your estate.

The two simplest strategies to minimize Uncle Sam's "inheritance" are (dark humor alert) (1) to die in 2010, when the ceiling on estate taxes disappears for a single year if current laws remain, or (2) to pay an estate-planning attorney to compose a very detailed will controlling the dispersal of your assets over time to avoid the IRS's wrath. Beyond that, more complex, specialized trusts such as family or credit shelter/bypass trusts, irrevocable life insurance trusts, and grantor-retained interest trusts can best perform tax gymnastics. For this article, we'll stick with the more common living trusts.

What a trust really does
Like a safety deposit box, an IRA, or a piggy bank, a trust is simply a parking spot for your life's riches. A revocable living trust is established while you're alive and holds all assets in which a beneficiary is not named. After you move your assets into it, things pretty much proceed as normal. Although the trust is the legal owner of your bounty, if it's a revocable living trust, the trustee (typically you) still calls all the money-management shots, and the beneficiary (you again) is free to live off the trust's largesse. There are two main benefits of a living trust:

1. No probate: Complete privacy is something that even the best-written will cannot provide. Since assets placed in a trust are not subject to probate, your estate is spared a very public and often lengthy court proceeding. The trust acts like a bouncer that turns away rubbernecking neighbors, court employees, and blacklisted heirs trying to hop the velvet rope. Avoiding probate can save your family a mint, as settlement costs alone can gobble up 5% or more of an estate's gross value.

2. Smooth passage of assets: A living trust was a godsend for one Fool. After her father passed away, his portion of the family assets moved into the trust, as stipulated in his will. Probate was brief, and there was no hassle of retitling assets or transferring accounts. Her mother sold her house with ease because she didn't have to get court supervision of the liquidation. This was a far cry from the ordeal after our Fool's grandfather died. He had only a simple will, and all of the family assets were in his name. Although he had named his wife the beneficiary, she was frozen out of all the money until almost a year later, when the probate process was finally complete.

Like a living trust, a testamentary trust helps you retain control of how your assets are dispersed. When you make your final earthly transaction (our condolences), assets move into the trust as specified in your will. However, since the will directs your assets, your estate will still go through probate, but it will be a much shorter version of the process.

Test your trustworthiness
Complex finances, control-freak tendencies, fondness for your estate lawyer's waiting-room coffee, and an aversion to probate court are all valid reasons for establishing a testamentary or living trust. Other key factors to mull over:

  • Are your state's probate laws particularly arduous? (Find your state court's website.)
  • Will you be leaving a fortune to your heirs -- an amount north of $2 million in gross assets, including real estate, gold doubloons, and other valuables?
  • Will your heirs pay inheritance taxes if they claim all of their winnings at once instead of cashing in on tax-free portions over time?
  • Do you want to orchestrate post-mortem, long-term payouts to disabled relatives, secret loves, charities, and your Maltese lapdog?
  • Do you want to insulate your heirs' inheritance from lawsuits, future divorces, or spendaholic relapses?
  • Would you prefer a trustee to manage the money you leave behind?

One last reminder: As dreamy as a living trust might sound, remember that a well-executed will can steer your estate around many of these events.

For more on getting your estate in order, read about: