A trust is a legal entity that you can transfer your money and property into for your future heirs and loved ones, and a testamentary trust is a trust created by the terms of a will. In addition to stating who should get your possessions and property when you die, your last will and testament can include instructions to establish a trust and what assets should be transferred into it. The testamentary trust is only effective after the writer of the will (also known as the testator) dies, which makes the testamentary trust an irrevocable since it can no longer be changed.
Testamentary trusts are easy to create and can provide you with some control over how beneficiaries can use the assets they receive. They can be a useful tool in estate planning to pass an inheritance on to a minor child who is too young to manage the money or assets themselves. But because the trust assets don't transfer into the trust while the trust maker (trustor) is still alive, the estate won't avoid probate — which is one the primary reasons to open a trust in the first place.
A testamentary trust only takes place after the trust creator/will-writer dies.
You can’t avoid probate with a testamentary trust.
Testamentary trusts may not have the same tax advantages as an irrevocable living trust.
How does a testamentary trust work?
A testamentary trust is created through a will, which you can either get by asking an estate attorney to prepare one for you or make one yourself online. After you die, assets you specify will be transferred into the testamentary trust.
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You don't need to put everything into your testamentary trust; you can still give away assets directly to some beneficiaries through the will. The trust will last as long as you specify, until the trustee distributes money and assets in it according to your wishes. You can also open more than than one testamentary trust. For example, you might create separate testamentary trusts for your children and spouse.
To create a testamentary trust, you need to specify the following in your will:
You'll want to choose someone that you can count on act as trustee and distribute it to your beneficiaries. The trustee can even be the same person as the executor (personal representative) who is in charge of managing your estate once you’ve passed away. You may even name a successor trustee, who takes over if the trustee is unable to do so, as well as co-trustee.
You can modify the terms of your testamentary trust by updating your will. You can do this at any time, since the trust only exists on paper in the terms of your will. But once you pass away, the terms of the trust will be executed and they will be irrevocable, meaning that they can't be changed (unless you explicitly directed your will to create a testamentary trust that allows for amendment after your death).
How is a testamentary trust different than a living trust?
A testamentary trust is created when the grantor dies, but a living trust — also called an inter vivos trust — is created while the grantor is alive. Living trusts can typically be changed, though some people create irrevocable living trusts, but testamentary trusts are always irrevocable since the grantor isn’t around to revoke it.
Another difference between a testamentary and living trust is that living trusts can offer more privacy because assets in this trust don't go through probate. The details of the trust document, like who the trust beneficiaries are, and what assets they receive, are shielded from the public. Provisions of a testamentary trust on the other hand are stated directly in the will, which eventually becomes part of the public record.
Other types of trusts
Trusts can be further broken down into different types, depending on their goals and what they achieve. A testamentary trust could also be a family trust, which holds assets for your family, while a spousal testamentary trust holds assets for a surviving spouse. If the trust is meant to help minimize your spouse's future estate value, then it might be a bypass trust.
If your testamentary trust holds an inheritance for a beneficiary with special needs, then you might have a special needs trust. Most types of trust that you want can be created as a testamentary trust, but a more complex trust usually requires the help of an estate attorney.
Benefits of a testamentary trust
In estate planning, testamentary trusts can be useful if you want to pass an inheritance on to a young child who can’t handle their finances yet and provide guidelines as to how the trust property should be used. You can create a trust fund that holds money for the beneficiary until they become a legal adult or some other age that you specify.
Testamentary trusts can also be set up to safeguard your trust beneficiaries property during a lawsuit. For example, If your spendthrift son owes money, his creditors cannot collect money from the testamentary trust.
Easy and cost-effective
Testamentary trusts can be easier and cheaper to set up then other types of trusts since testamentary trusts simply require writing a will. Setting up a living trust during your lifetime could cost $1,000 or more, but writing a will is usually much cheaper.
A testamentary trust may also have lower maintenance costs, like trustee fees, than a living trust which might have to be managed over the course of your lifetime. Trustee fees are also higher if you use an attorney or financial institution.
Disadvantages of a testamentary trust
Choosing not to set up a trust during your lifetime and creating a testamentary trust through a will instead can have a few drawbacks.
Testamentary trusts do not avoid probate
One of the essential benefits of a trust is avoiding probate, the legal process of settling the decedent's estate and distributing their assets. However, a testamentary trust won't transfer assets outside of probate, since the assets are still owned by the grantor at the time of death. (They haven't been transferred into the trust yet.) That means your executor may need to petition the probate court to prove the terms of your will before the trust can be established.
Probate can delay how long it takes for your beneficiaries to receive their inheritance.
Testamentary trusts have fewer tax benefits than other trusts
Because the assets are in the grantor's control until their death, creating a testamentary trust won't help minimize estate tax or income tax. You typically need to relinquish control of your assets ahead of time to take advantage of these tax advantages. Your estate may be able to receive tax deductions if the testamentary trust is making charitable donations (like if you set up a charitable trust) but it might take some planning or working with an attorney.
Testamentary trusts have limited protections for the grantor
Transferring everything into a testamentary trust upon your death will not prevent creditors from coming after your estate. Anyone who you owe a debt to can petition the probate court seeking repayment before assets go into the trust.
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