Testamentary Trust

What Is a Testamentary Trust?

A testamentary trust is a trust that is established in accordance with the instructions contained in a last will and testament. A trust is a fiduciary relationship that allows a trustee, who is a third party, to manage assets on behalf of the beneficiaries of the trust.

A person's will may include instructions to establish a testamentary trust so that the trustee can distribute the person's assets to the beneficiaries outlined in the will. However, a testamentary trust is not created until after the person has passed away. Also, a will could have more than one testamentary trust.

Testamentary trusts can be helpful as a part of an overall wealth management strategy since they provide instructions for distributing the assets within a decedent's estate. However, there are both advantages and disadvantages of testamentary trusts that should be considered before including one in a will.

Understanding a Testamentary Trust

A testamentary trust is created to manage the assets of the deceased on behalf of the beneficiaries. It is also used to reduce estate tax liabilities and ensure professional management of the assets of the deceased.

A testamentary trust doesn't exist until the person passes away, meaning the trust is essentially part of a set of instructions within a person's will to be drafted by a predetermined representative called an executor or executrix. The deceased's assets will be transferred into the newly created trust only after the person has passed away.

A testamentary trust can be established so that the deceased's assets are paid to the beneficiaries only when certain conditions have been met. For example, the language within the trust may state that the assets may be accessed by a child of the deceased for educational expenses until the child reaches the age of 25, at which time the balance will be paid out.

A testamentary trust might also be created to manage the charitable distribution of assets in accordance with the wishes of the deceased.

Requirements for a Testamentary Trust

A testamentary trust usually involves three parties: The grantor or trustor who creates the trust, the trustee who manages the assets held in trust, and the beneficiary or beneficiaries named in the will. A trustor has the option of setting up a testamentary trust, which will be established upon the death of the trustor.

The testamentary trust is a provision within the will that outlines the estate's executor and instructs that person to create the trust. However, the trust is not immediately established after the person's death since the will must go through the probate process. Probate is the legal process through a local court that verifies the authenticity of a will and the named executor or executrix.

A testamentary trust remains in effect until a triggering event is named in the will, such as a surviving child reaching the age of 21.

Once the probate process has been completed, the trust can be established and the executor transfers the property into the trust. The assigned trustee manages the assets until the trust expires and the beneficiary receives the assets.

The trust's expiration date is usually tied to a specific event, such as the beneficiary reaching a certain age or graduating from college. Until the trust expires, the probate court may check in periodically to ensure that the trust is managed properly.

The trustor can choose anyone to act as a trustee. However, the trustee appointed is not obligated to take on this role and may decline the request. If this happens, the court may appoint a trustee or a relative or friend of the beneficiaries involved may volunteer to act as the trustee.

Testamentary Trust vs. Living Trust

A testamentary trust is a trust that is to contain a portion or all of a decedent's assets outlined within a person's last will and testament. A testamentary trust is not established until after the person passes away in which the executor or executrix settles the estate as outlined in the will.

Conversely, a living trust is a trust that is established during the person's lifetime in which an appointed person — the trustee — is responsible for managing the person's assets for the benefit of the beneficiary or beneficiaries of the trust.

Although the instructions for a testamentary trust are outlined while the person is still living, the trust itself is not established until after the person passes away; only then can assets be distributed and placed into the trust. However, a living trust — also called an inter-vivos trust — allows for more involvement from the trustor since they're alive when the trust is established.

Also, a living trust can be revocable, meaning the trustor can change it. A living trust can also be irrevocable, meaning it cannot be changed once established. However, a testamentary trust cannot be revocable and is typically established as irrevocable since the trustor has passed away.

Advantages and Disadvantages of a Testamentary Trust

A testamentary trust has both advantages and disadvantages. Although a testamentary trust can be an effective estate planning tool, whether it's beneficial or not for a person's financial situation can depend on several factors.

Advantages

A testamentary trust can be helpful if the decedent, such as a parent, has young or minor children and want their assets distributed to them if they pass away prematurely. A parent's testamentary trust can be established with instructions that the funds would only be distributed to the beneficiaries following a specific milestone. For example, funds from the trust would not be distributed to a decedent's children until they turn 18 years of age.

Another advantage to a testamentary trust is that it can be modified while the person is still alive since the trust has not come into existence yet. In other words, a testamentary trust is essentially a revocable trust, since a will can be changed at any time before a person passes away.

In some cases, parents of young children might not have substantial financial assets, or perhaps a couple may not be able to afford the cost of establishing a living trust. Instead, they can create a testamentary trust within their will, which would only come into effect if they passed away.

Although there's still a cost to create a will, the cost of the testamentary trust would come out of the decedent's estate, avoiding the expense of creating a trust while still alive. If it turns out that later in life, they can afford to establish a trust, the testamentary trust instructions can be removed from the will, and a living trust can be established instead.

Disadvantages

A major disadvantage of a testamentary trust is that it does not avoid probate, which is the legal process of distributing assets through the court. In other words, the executor or executrix must go to the local court with the decedent's will and testament and other documents to prove that they have the right to distribute the decedent's assets and establish the testamentary trust.

The probate process is necessary to move the assets into the beneficiary's name, which can take several months to complete. Since the testamentary trust would not be established until after the person passes away and the probate process has begun, the beneficiaries of the decedent's assets may not receive their assets for several weeks or months.

Another disadvantage of a testamentary trust is that, since it must go through probate, it becomes a public record. As a result, the beneficiaries of the testamentary trust would also be a public record.

There could also be confusion or a lack of clarity within the will, and after a person passes away, the testamentary trust may not be established properly. By not establishing the trust when the person is alive, such as the case with a living trust, there is a risk that certain details could be overlooked and the wishes of the deceased are not properly executed.

Example of a Testamentary Trust

Consider that a benefactor established a testamentary trust for a beneficiary. Under the terms of the trust, they will receive half of the assets at age 35 and the second half at age 55. Let’s say the benefactor is leaving $200,000 to a beneficiary. Setting up a testamentary trust helps ensure a level of financial oversight, preventing the beneficiary from impulsive expenditures at an early age.

Consider another example where the deceased trustor has created a testamentary trust for their spouse, who is a Medicaid applicant. Assets in the testamentary trust may be used to pay for medical expenses that are not covered under Medicaid, such as specialist evaluation, special equipment, or additional therapy. Under a testamentary trust, the value of assets will not factor into the spouse's Medicaid eligibility.

Testamentary FAQs

What is a testamentary document?

A testamentary document is a document that is added to a person's will outlining specific information or instructions. A testamentary document could include a confidentiality agreement or an indemnity document, which may remove all financial, legal liability for a person or party.

Why do you need a letter of testamentary?

A letter of testamentary is important since it is issued by the probate court, assigning the executor or executrix named in a person's will with the legal power to act on behalf of the deceased person's estate. The letter of testamentary, along with the person's death certificate, is usually needed in order for the executor to conduct financial transactions on behalf of the estate.

Do I need a lawyer to get a letter of testamentary?

Typically, a lawyer or attorney is necessary to get a letter of testamentary during the probate process, particularly if there are multiple beneficiaries. However, laws can vary, depending on each state, and in some cases, a non-attorney may be allowed to manage the probate process for a deceased person.

How much does it cost to get letters of testamentary?

The cost of a letter of testamentary can range from less than $100 to more than $1,000, depending on the size of the person's estate and the number of assets involved.

The Bottom Line

A testamentary trust can be an effective estate planning and wealth management tool that help ensure a person's beneficiaries receive the assets they're entitled to after the person has passed away. However, there are many types of trusts available, and it's important to contact an expert, such as an attorney or financial professional, to determine what type of trust is best for specific financial circumstances.