When it comes to estate planning, you may have heard of a Testamentary Trust. This type of Trust can provide for your loved ones while ensuring your assets are managed according to your wishes after death. But many people misunderstand how this type of Trust works and how to create one.
Trusts are highly versatile estate planning tools. But they’re not for everyone. Their usefulness and value depend on what your objectives are. Also critical is proper funding of the Trust, which many people overlook.
Let’s run through how a Testamentary Trust works, who they might benefit, and how they compare to other types of Trusts.
What is a Trust?
Before discussing the Testamentary Trust, let’s first define a Trust more generally. A Trust is a legal arrangement between three parties: Settlor, Trustee, and Beneficiaries.
The Settlor creates the Trust. The Trustee manages the assets in the Trust. And the Beneficiaries receive the benefits of the Trust.
There is a fiduciary relationship between the Trustee and the Beneficiaries. The Trustee must act in their best interest with the assets held in the Trust.
Trusts usually have a written instrument, with the provisions covering a vast array of potential situations. This includes who the parties to it are, the governing state law, Beneficiary rights, Trustee powers, and the ultimate plan of distribution.
There are two types of Trusts (for purposes of this article): Living and Testamentary. To read more about Living Trusts, you may read another of ours article here.
How to Create a Testamentary Trust
Creating a Testamentary Trust begins with executing a Last Will & Testament. The Testator (person making the Will) works with an attorney to draft it. He or she then signs the Will with two witnesses, who also sign it.
The Trust in the body of the Will itself. There are specific Articles outlining the terms of the Trust, including the Trustee, Beneficiaries, and how to manage and distribute assets.
A Testamentary Trust does not exist during one’s lifetime. It exists only after death. The Will must go through probate in order to create the Trust. Probate is a court-supervised process that validates the Will and settles the estate.
If the Testator is living and has the required legal capacity, he or she can change the Will and its Trust provisions at any time. This allows individuals to adjust their plans as circumstances change.
Probate can be a time-consuming process, though. This may delay the funding of the Trust. Despite this, Testamentary Trusts remain a practical solution for many estate planning needs.
Who Can Benefit from a Testamentary Trust?
Testamentary Trusts can work for a variety of individuals and families. One common scenario involves married couples with “mirror image” estate plans. Each spouse’s Will gives their entire estate to the survivor as the primary disposition plan.
But if they both die simultaneously, then their Wills each create a Testamentary Trust for their Beneficiaries. This is usually their children.
This type of Trust ensures that their children are cared for and that a responsible party oversees things. The Trustee invests the assets until the children reach an appropriate age or milestone. The Trustee may also make some distributions, depending on the Trust’s terms.
Other individuals who might benefit from a Testamentary Trust include:
- Single parents: This type of Trust is less expensive than a Living Trust, but still provides an avenue to provide for minor children.
- Blended families: These trusts can help ensure children from prior relationships are provided for while balancing the needs of a current spouse.
- Children with special needs: A Testamentary Special Needs Trust can protect a Beneficiary’s eligibility for government benefits.
- Those concerned with asset protection: Testamentary Trusts can include provisions to shield their Beneficiaries from creditors, divorce, or wasteful spending.
Testamentary Trust vs. Living Trust
A Testamentary Trust and a Living Trust differ in their timing of creation. The Settlor of a Living Trust creates it during his or her lifetime, as the name implies. The Trustee, often the Settlor, manages assets in the Trust immediately.
A Testamentary Trust, on the other hand, is dormant until the Testator’s death and completion of probate. This means there is a longer process to fund a Testamentary Trust as opposed to a Living Trust.
Testamentary Trusts require less work upfront to put in place. There’s no need to retitle assets after you execute the Will that has the Trust. But probate is required, which can add substantial work and expense later on.
Living Trusts avoid probate. But they are more expensive and require more effort to set up and maintain. Choosing between the two depends on your priorities and circumstances.
Pros and Cons of a Testamentary Trust
As with anything, each and every estate planning option has benefits and drawbacks. These are just a few for Testamentary Trusts.
Pros:
- Easier and less expensive to set up compared to Living Trusts.
- Flexible, as the Testator can amend his or her Will at any time as long as there is legal capacity.
- Effective for specific scenarios, especially for young families with mirror-image type estate plans.
Cons:
- Requires probate, which can be time-consuming and is open to public inspection.
- Updating Beneficiary Designations at financial institutions can be cumbersome, as some may not work well with Testamentary Trusts.
- Delays in funding the Trust may occur due to the probate process.
Final Thoughts on Testamentary Trusts
Testamentary Trusts are a fairly cost-effective and practical estate planning tool. They work well for young families and individuals with specific needs, such as planning for minor children, blended families, or asset protection.
Just like with any estate planning decision, it’s important to understand how this tool works and to have legal counsel working with you so you make the right choice. What’s right for another family may not be right for yours.
If you’re considering a Testamentary Trust, Connell Law, PLLC can help you determine if it’s right for you. We serve Rutherford County, Tennessee and the surrounding area in the areas of estate planning and probate.
Contact us today to request a free consultation for your tailored legacy plan.
