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Your property and belongings can be moved into a trust when you die.
Did you know that your last will and testament can create a trust upon your death? A testamentary trust is one that only goes into effect when the writer of the will (also know as the testator) dies. Your will designates which assets go into the newly created trust.
In estate planning, testamentary trusts can be useful if you want to pass an inheritance on to a young child and provide guidelines on how the money can be used. It is an alternative to a living trust and has some key differences, too. Your assets will have to go through probate, and you might not always be able to reduce or eliminate estate taxes.
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Since a will establishes a testamentary trust, the first step is to write one. You can even write a will online.
A will is a legal document with instructions as to what happens to your property and valuables when you die. When you direct your assets to pour over into a trust after death, this is the testamentary trust.
There are a few things the will must do to create a testamentary trust:
You’ll need to state which assets should transfer (or pour over) into the trust. You don’t need to move all of them; you can still give away some of your assets through the will. You can also create more than one testamentary trust. For example, you might create separate trusts for your children and spouse and leave property to each.
For example, you might dictate that your child can only receive your inheritance after he or she turns 18 or graduates from college. You can even decide how much can be withdrawn at a time.
Try to be specific and leave little room for interpretation — stating that inheritance should be used to pursue interests might be too broad and result in a misuse of funds. Seeking an estate planning attorney to write the trust document for you might help prevent any legal issues between your heirs and trustee down the road.
Read more about naming beneficiaries for your estate.
The trustee is the person in charge of handling the trust. You’ll want to choose someone trustworthy to properly distribute the assets to your beneficiaries.
The trustee can be almost anyone, including a lawyer or financial institution. You might even be able to appoint a beneficiary, depending on the state, though it likely isn’t legal if the beneficiary is a child. An estate planning attorney can help you find your away around the state laws.
You can change the terms of the testamentary trust at any point, since it only exists on paper through the will. But once you pass away, the terms of the trust are irrevocable, meaning that they can’t be changed. This is a difference between testamentary trusts and other types of trust, which we’ll discuss next.
Since testamentary trusts are effective only upon the death of the testator, the opposite of a testamentary trust is a living trust, or inter vivos trust, which is created while the grantor (or trustmaker, also known as a settlor) is still alive.
Revocable inter vivos trusts can be modified, while irrevocable ones cannot. Irrevocable trusts can be further broken down into different types of trusts, such as those designated/intended specifically for a life insurance policy or a beneficiary with special needs.
Read a detailed guide to irrevocable trusts (including life insurance trusts and disability trusts).
One key difference is that testamentary trusts do not always have the same tax advantages (minimizing estate tax, income tax, or capital gains tax) that affect the other trust types. This is primarily because the assets are in your control until your death. (You typically need to relinquish control of your assets ahead of time to take advantage of those tax benefits.)
There are however two exceptions to this. The estate can receive tax deductions if your will instructs your assets to be moved into a charitable trust and the estate value (and therefore estate tax) can be minimized if the will creates a bypass trust. If you’re married, you can designate your assets to go into a bypass trust (also known as a credit shelter trust or B trust) when you die. If the value of assets are less than the federal estate-tax exemption, then your surviving spouse (the beneficiary) will not be responsible for the estate tax.
Testamentary trusts might be less costly, especially if it doesn’t last for a long period of time (for example, once the child beneficiary reaches a certain age). Trusts might have annual maintenance fees when the trustee is an attorney or financial institution. Therefore living trusts could be more expensive, since they are might be opened and managed over the course of your lifetime.
Another difference between the two trust types involves privacy. The details of the probate process — like who the beneficiaries are, and what assets they receive — are shielded from the public when you disburse your property and belongings with a typical living trust. But, since testamentary trusts stem from a will, which must go through probate, the proceedings and details of probate will become part of the public record and will become available at the local probate clerk’s office.
As we just mentioned, probate procedure differs between testamentary trusts and living trusts. We’ll discuss probate and testamentary trusts next. Also, you can read more about trusts vs wills.
Thinking about retirement?
A will is the best way to ensure your property goes to your loved ones after you die.
Avoiding probate is one of the essential benefits of a trust. Inter vivos trusts skip this legal process, through which assets are distributed, since the assets are already held by the trust.
However, with a testamentary trust, the assets haven’t been transferred and are still owned by the settlor until he or she dies. So, testamentary trusts do not avoid probate, which is required to move the assets into the trust. If you have any creditors, they might also have a claim to these assets since have not yet moved into the trust.
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Policygenius’ editorial content is not written by a certified financial planner or advisor. It’s intended for informational purposes only and should not be considered legal, financial, or investment advice. Consult a professional to learn what financial products are right for you.
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