Testamentary Trusts

Testamentary trusts are trusts contained in a will.

They are created to achieve specific objectives.

For example, testamentary trusts can be used to ensure legal guardianship for minors or individuals with special needs after the will creator’s death.

They can also be used to make regular charitable contributions.

Because they are contained in a will, testamentary trusts are still required to undergo a court-supervised probate process.

How Are Testamentary Trusts Used for Estate Planning?

Testamentary trusts are similar to regular trusts in that they require transfer of assets into a trust and can generate regular income for beneficiaries.

A trustee is also responsible for managing testamentary trusts, just like regular trusts.

However, unlike regular trusts which become active immediately after creation, testamentary trusts become operational only after death of the grantor or the owner of assets in the trust.

Essentially, the grantor provisions for the creation of a testamentary trust in his or her will.

In that sense, testamentary trusts are different from inter-vivos trusts which are trusts created during an individual’s lifetime.

In their will, grantors also list assets that are to be included in the trust and appoint a trustee responsible for managing the trust’s affairs.

The trustee has a fiduciary duty to act in the beneficiary’s best interests.

Testamentary trusts are most common in situations that involve legal guardianship of minors or individuals with special needs.

For example, you can insert provisions for creation of a testamentary trust in your will to support your children financially until they are able to manage their affairs.

Now, suppose one of your children has special needs and it is likely that he will never become independent financially.

Then you can create two trusts in your will, one for each of your children. The terms for each trust may vary depending on circumstances.

If you are interested in charitable giving, then you can create multiple trusts to make regular donations to your favorite charities or causes.

While it is possible to create multiple testamentary trusts in a single will, you must remember that a testamentary trust is an irrevocable trust i.e., its terms and composition cannot be changed after it becomes active.

What are the advantages and disadvantages of testamentary trusts?

Incorporating a testamentary trust into a will has its own set of advantages and disadvantages.

Some of the advantages of testamentary trusts are listed below:

  • Testamentary trusts are more flexible than a will. They allow creators of a will to appoint legal guardians for children or people with special needs. You can also appoint legal guardians using a will. But a trust offers a regular stream of income for beneficiaries. In effect, a testamentary trust provides a benefit of the trust structure inside a will.
  • Testamentary trusts are easier to set up and do not incur as much fee as compared to regular living trusts. This is primarily due to two reasons. The first one is that they are contained in a will, which requires less upfront costs to set up. The second reason is that testamentary trusts do not become active immediately. Therefore, they do not require regular maintenance charges or the conveyance of assets into a trust – an expensive process that incurs lawyer and asset retitling fees.
  • Testamentary trusts offer tax benefits to beneficiaries once they become active. This is because they are irrevocable trusts which “lock in” assets for the duration of their term.

The disadvantages of testamentary trusts are as follows:

  • A major disadvantage of testamentary trusts is that they are subject to a court-supervised probate process. Testamentary trusts are contained in a will and all wills must undergo a court-supervised probate process during which the estate is assessed, pending taxes are paid, and creditor claims are considered. It can be a lengthy and expensive process, if the estate is complex and has multiple beneficiaries and pending claims. There might even be a possibility that the original amount set aside for a testamentary trust may be reduced due to claims and taxes incurred.
  • The tax benefits of testamentary trusts are limited. Because the trust takes effect only after the will creator’s death, a testamentary trust does not offer tax advantages to them while they are alive.

How can you create a testamentary trust?

The process to create a testamentary trust is similar to that of a regular trust, with the exception of a couple of steps.

Make an inventory of the assets that you’d like to include in the trust and include the list in your will.

Ensure that you have the title deeds for these assets.

If you have assets that you’d like included but they are not listed in the original will, make sure that you include them in a pour-over will.

This type of will “pours over” assets left out in a will or from a trust into the designated estate instrument.

Name a trustee and a beneficiary (or beneficiaries) for your testamentary trust.

Some individuals also name a succession trustee, who will take over the original trustee’s duties if they pass away or become mentally incapacitated.

Most testamentary trusts also have a closing date.

This is the date when the assets contained in the trust are transferred to the beneficiary and trust payouts stop.