A testamentary trust is a trust agreement written and designed to go into effect after your death. As opposed to the more popular living trust, wherein the trust becomes valid as soon as it is signed and notarized, a testamentary trust is established through a last will and testament.
Trusts and wills are often compared against each other, but the two can be used to complement one another. Wills can be used to send estate items into an existing trust, or even to create a trust after death. Trusts can be used alongside wills to distribute assets outside of probate, while the will names guardians for surviving minor dependents, or determines how the leftover estate is distributed among the living within probate.
In the case of a testamentary trust, the general purpose of the document is to provide instructions for distributing assets within an estate as part of a larger wealth management strategy. There are pros and cons to a testamentary trust over a living trust, or a trust-less estate plan. To understand these differences, it helps to refresh our understanding of how trusts work.
A Primer on Trusts
A trust is a legal entity defined and characterized by an accompanied trust document and established between three parties: the grantor/trustor, the trustee, and the beneficiaries.
The trustor creates and sets limits for the trust, funding their assets into it, and creating the asset list that describes the trust’s contents.
In the context of a living trust, it is their responsibility to establish the trust and ensure that all proper ownership documents regarding the assets and properties listed in the trust are amended to reflect their status under the new trust. In the context of a testamentary trust, the trustor may establish the step-by-step instructions for the execution of the trust under their last will and testament.
The trustee or successor trustee is the trust’s de facto manager. Upon a trust’s creation, they are responsible for managing the items within the trust and ensuring their upkeep until the trust is dissolved and distributed among its respective beneficiaries.
Not all trusts are designed solely to transfer assets between generations upon death. Some trusts are built to ensure the financial security of a dependent with special needs, for example. Some trusts are meant to be managed as an investment fund, paying out annual or monthly dividends, either as a fixed amount or as a percentage of profit over the year.
In that light, trustees can be individuals, such as a close friend or lawyer, as well as institutions, such as banks and investment firms. When an individual is named as trustee, the trustor may also name a successor trustee (or multiple successor trustees) should the first choice pass away or decide to retire their title to their chosen successor.
In the case of a living will, for example, a trustor can name themselves as trustee of the trust and name a successor trustee to take over the task of managing and distributing the trust upon their death.
Finally, the beneficiaries of a trust reap the benefits of the trust’s creation, whether as part of a steady income, or as part of or the totality of the trust’s principal (what was originally funded into it). Beneficiaries may be family members and friends, but they may also be organizations, charities, businesses, and groups.
Unlike a will, a trust need not be legitimized through probate. Trusts are signed, witnessed, and notarized, and often go into effect before the grantor dies. A testamentary trust is established within probate, however, and must be established by your executor within the probate process. This is somewhat different from establishing a living trust on your own.
The Testamentary Trust
The main distinction between a living trust and a testamentary trust is that a testamentary trust is created in death, through the instructions of a last will and testament.
Because a will must be probated before it can be executed, the steps to creating and taking over a testamentary trust require that someone petitions the local courts to start probate, thus naming an executor for the decedent’s estate and legitimizing the will.
This means a testamentary trust cannot avoid probate, which is a crucial disadvantage versus living trusts. This means that an executor must obey the general step-by-step rules of the probate process, and prioritize the establishment of the estate’s inventory and total valuation, as well as the notifying of creditors.
Only once the estate has paid its dues can its assets be funded into a testamentary trust. This process can take months, which eliminates many of the benefits of utilizing a trust in an estate plan to begin with.
Besides this crucial difference in the way testamentary trusts interact with probate, living trusts and testamentary trusts are functionally identical. Both allow for flexible estate planning. Both can be used to provide for a surviving spouse or minor child. Both can hold assets and manage wealth until requirements and conditions are met, even years after the grantor’s death. Both can be used to provide income for family members for a set period of time, and then bequeath the remainder to charity. Both offer distinct tax advantages and capital gains tax benefits over other estate planning methods.
In general, testamentary trusts are not used as often as living trusts. But if the need arises for a trust to be established only after death, testamentary trusts are an option.
Revocable vs. Irrevocable Trusts
Trusts are either revocable or irrevocable. Revocable trusts can be altered even after they have gone into effect. Irrevocable trusts are unalterable, unless through very specific circumstances.
The benefits of an irrevocable trust enable it to perform unique functions, including asset protection against creditors, and minimizing tax liability.
This is because an irrevocable trust (where the grantor is not named as a trustee) effectively cuts a grantor off from their trust-affiliated properties and assets, rather than letting them continue to be involved in their management.
This means any claims against the trustor do not affect the trust, and the trustor’s total estate value goes down by however much the trust has been funded with.
Testamentary trusts are irrevocable because they cannot be altered after the grantor’s death. However, because the assets within the testamentary trusts go through probate before the trust is created, a testamentary trust does not confer the same benefits as an irrevocable living trust.
Living and testamentary trusts can play an important role in your overall estate plan; or they might not be a good fit for your estate to begin with. It is important to consult with an estate planning professional before you decide to utilize a trust for your estate.
Trusts are a greater commitment than wills, as they must be continuously managed, and are thus costlier than a one-time will. However, for many estates, the benefits of a trust far outweigh its cost.