What Is Testamentary Trust & How It Works

How do testamentary trusts work?

A testamentary trust, as its name suggests, is born out of a will or testament. It’s a legally binding arrangement that comes into existence only after the death of the person who made the will, also known as the testator. Unlike living trusts, which are established and operational during the testator’s lifetime, testamentary trusts spring to life posthumously, offering a unique way for individuals to manage their assets after they’re gone.

The working of a testamentary trust involves three key parties: the testator, the trustee, and the beneficiaries. The testator is the person who creates the will and designates the assets to be put into the trust. The trustee, appointed by the testator, is responsible for managing and distributing the trust assets according to the instructions laid out in the will. The beneficiaries are the individuals or entities that stand to receive the benefits from the trust, such as the income from the assets or the assets themselves.

The testamentary trust springs into action upon the death of the testator. It doesn’t exist while the testator is alive. Instead, it’s essentially a set of instructions within the testator’s will. The will needs to be probated first, a process in which the court confirms the will’s validity. Only after the probate process can the testamentary trust be established. The assets specified in the will are then transferred into the trust.

The role of the trustee is critical in a testamentary trust. They carry out the testator’s wishes as outlined in the will. This can involve managing the assets, such as real estate, stocks, or cash, in the best interest of the beneficiaries. The trustee may also be responsible for distributing the assets to the beneficiaries as per the conditions set out in the will. For instance, a testamentary trust could stipulate that a child beneficiary can only access the funds for educational expenses until they reach a certain age, at which point they receive the remaining balance.

While the testamentary trust provides control and protection for the testator’s assets, it also requires ongoing management, potential court involvement, and possible additional costs. The testamentary trust remains in effect until a triggering event, usually specified in the will, such as a child beneficiary reaching a certain age.

A testamentary trust is a powerful estate planning tool that provides a way for individuals to control the distribution of their assets after death. The trust is created as part of a will and comes into effect after the testator’s death and the completion of the probate process. The trust assets are then managed and distributed by a trustee according to the stipulations in the will. Testamentary trusts offer a way to protect assets, provide for loved ones, and potentially reduce estate taxes, but they also come with their own set of complexities and potential costs. As always, it’s essential to consult with a legal or financial advisor when considering a testamentary trust as part of an estate plan

Who can be a trustee?

The grantor appoints a trustee in their last will and testament. Since the testamentary trustee is responsible for managing the trust, it should be someone who has the beneficiary’s best interest in mind. If the named trustee declines when the trust is established, the court can appoint a new one, or someone can volunteer.

Why do testamentary trusts go through probate?

Testamentary trusts are established as part of a last will and testament and therefore must go through the probate process, which authenticates the will. This does mean that testamentary trusts entail a bit less privacy and more court involvement than other types of trusts.

Testamentary trust vs. living trust

When planning for the future management and distribution of your assets, two main types of trusts often come into consideration: testamentary trusts and living trusts. Both can help ensure that your wishes are carried out, but they function in different ways and have distinct advantages and disadvantages.

A testamentary trust is a type of trust that is created upon your death, as outlined in your will. The assets you designate in your will are transferred into the trust after your death and after the will has been probated. The trustee you’ve appointed then manages and distributes the assets according to the terms you’ve specified in your will.

The testamentary trust does not exist during your lifetime, and changes can be made to the terms of the trust (which are outlined in your will) at any point during your life. Testamentary trusts can be useful in situations where you want to provide for minor children or other dependents who may not be able to manage a large inheritance on their own. They are irrevocable once they come into existence, as they’re created upon your death.

On the other hand, a living trust, also known as an inter-vivos trust, is established during your lifetime. You can transfer assets into the trust and designate how you want them managed and distributed, both during your life and after your death. The living trust can be either revocable or irrevocable.

A revocable living trust allows you to maintain control over the trust assets during your lifetime. You can serve as the trustee, manage the assets as you see fit, and make changes to the trust terms or even dissolve the trust entirely. Upon your death, the designated successor trustee will manage and distribute the remaining assets according to your instructions, bypassing the probate process.

An irrevocable living trust, once established, cannot be changed or dissolved without the consent of the beneficiaries. The assets in an irrevocable trust are removed from your estate, which can have significant tax advantages, but you give up control over these assets.

When comparing the two, a key difference is the timing of their creation and the control you maintain over your assets. A living trust allows for more flexibility and control during your lifetime and can help avoid the probate process, but it may require more effort and cost to set up and manage. A testamentary trust is simpler and less expensive to establish, as it’s part of your will, but it offers less flexibility, and the assets must go through probate before they can be transferred into the trust.

Choosing between a testamentary trust and a living trust largely depends on your individual circumstances, goals, and preferences. Factors such as the size and complexity of your estate, your desire for control over your assets, your concerns about privacy and probate, and your long-term family and financial goals can all influence the best choice for you. As always, it’s advisable to consult with a Wills and Estates lawyer or financial advisor when making these important decisions.

Testamentary trust example

Let’s consider an example to better understand how a testamentary trust might work:

Imagine Sarah, a single mother of two minor children, Tim and Lisa. Sarah has a substantial amount of assets, including her home, a savings account, and a life insurance policy. She wants to ensure that her children are well taken care of if anything were to happen to her. However, she’s concerned that they might not be able to responsibly manage their inheritance due to their young age.

To address this concern, Sarah decides to include a testamentary trust in her will. She appoints her brother, Mike, as the trustee. In her will, she outlines that upon her death, her assets should be transferred into the trust. Mike, as the trustee, would then be responsible for managing the assets on behalf of Tim and Lisa.

Sarah includes specific instructions in the trust terms. She stipulates that the funds should be used for Tim and Lisa’s health, education, maintenance, and support. She also decides that the children should receive their inheritance in stages, rather than in a lump sum. They will receive a portion of their inheritance when they reach the age of 25, and the remainder when they turn 30.

In this example, the testamentary trust doesn’t come into existence until Sarah’s death. Until then, she’s free to change the terms of the trust or even revoke it entirely. After her death, the will would go through probate, and then the assets would be transferred into the trust. Mike, as the trustee, would then carry out Sarah’s wishes as outlined in the trust, ensuring that Tim and Lisa are cared for and that the assets are managed in a way that aligns with Sarah’s intentions.

This example illustrates how a testamentary trust can provide a means of controlling how and when beneficiaries receive their inheritance, especially when the beneficiaries are minors or otherwise might not be able to manage a large inheritance on their own.

Advantages of a testamentary trust

A testamentary trust is a type of trust created in accordance with the instructions outlined in a person’s last will and testament. It comes into effect only after the person’s death, and it enables a designated trustee to manage the decedent’s assets on behalf of the named beneficiaries. The main purpose of a testamentary trust is to provide a structured and controlled way of distributing the assets within a person’s estate after they pass away1.

There are several advantages to a testamentary trust. 

• • One of the primary benefits is the control it gives the trustor (the person creating the trust) over the distribution of their assets. By setting up a testamentary trust, an individual can dictate the terms under which their beneficiaries receive their inheritance. For instance, a testamentary trust can stipulate that a child beneficiary can only access the assets for educational expenses until they reach a specific age, at which point the remaining balance will be paid out1.

• • Tax advantages are another benefit of testamentary trusts. In some cases, they can help avoid estate taxes and provide certain tax benefits for the beneficiaries. However, the specifics of these benefits can vary based on individual circumstances and local tax laws.

• • Testamentary trusts are also valued for their simplicity and flexibility. Establishing a testamentary trust is typically a straightforward process, as it can be incorporated into a will either during its creation or as a later addition. Furthermore, testamentary trusts can be customized to meet the unique needs of the trustor and beneficiaries. For instance, they can be particularly beneficial for those with special needs children, allowing the trustor to provide financial security for their child while ensuring the funds are managed by someone they trust2.

Disadvantages of a testamentary trust

Sure, here are the key disadvantages of a testamentary trust, each summarized in a separate point:

• • Ongoing Maintenance Costs: While the initial setup of a testamentary trust can be quite straightforward, the ongoing costs can accumulate over time. These costs can include legal fees, accounting fees, court costs, and trustee fees. Regular accounting and reporting of the trust’s assets might necessitate professional help, adding to these costs1.

• • Trustee Acceptance and Performance: The person you name as trustee of your testamentary trust has the right to decline the role. If the chosen trustee declines or is unable to perform their duties, a court may appoint a replacement. This person might not be someone you would have chosen, and they might not be as invested in carrying out your wishes as you intended1.

• • Probate Process: A testamentary trust, unlike a living trust, has to go through the probate process. Probate is a court-supervised procedure that can be lengthy and costly, and it can delay the beneficiaries’ access to the trust assets. Probate proceedings are also public record, which means the details of your estate and the testamentary trust could become publicly available information.

• • Irrevocability: Once established, a testamentary trust is irrevocable, meaning that once the testator (the person who made the will) passes away, the terms of the testamentary trust can’t be changed. If circumstances change for the beneficiaries or if there was an error or omission in the trust’s terms, it can be difficult to adjust. In contrast, a living trust, established while the trustor is still alive, can be either revocable or irrevocable, offering more flexibility.

Conclusion

A testamentary trust can be a great low-cost option to ensure the protection and proper distribution of assets to beneficiaries after death. Talk with an estate planning attorney or financial advisor to see if setting up a testamentary trust would be beneficial for you and your family.