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Updated on Tuesday, February 23, 2021
A testamentary trust is a specific type of trust that’s created by a last will and testament, or becomes irrevocable when the grantor or trust creator dies. Testamentary trusts can be used to create a legacy of wealth for family members, distribute assets to charity or manage the transfer of business assets. This type of trust can be useful in estate planning, though there are some cons to consider, along with the pros, when deciding if a testamentary trust is right for you.
- What is a testamentary trust?
- How does a testamentary trust work?
- What’s the difference between a testamentary trust vs. living trust?
- Advantages and disadvantages of a testamentary trust
- How to set up a testamentary trust
What is a testamentary trust?
If you’re looking for a simple testamentary trust definition, it’s a trust that takes effect when someone passes away, and is typically found within someone’s last will and testament.
A frequently asked question about these estate planning tools: Is a testamentary trust revocable or irrevocable? And what does that mean? A testamentary trust is irrevocable, meaning it cannot be modified or revoked once the trust creator passes away. Its terms become permanent, unless potential changes are specified by the grantor ahead of time. Revocable trusts, on the other hand, can be changed up until the trustmaker’s death.
Testamentary trusts can be used to hold a variety of assets, similar to the way other trusts work. The types of assets you may transfer to a testamentary trust include:
- Real estate
- Stocks, bonds and other securities
- Personal papers
In terms of estate planning uses, there are different applications for testamentary trusts. For example, you may choose to:
- Establish a testamentary trust to donate assets to charitable and nonprofit organizations
- Use this type of trust to pass on assets to your spouse as part of a tax management strategy
- Create a testamentary trust to hold business assets you own with one or more partners
Additionally, “a testamentary trust is appropriate any time someone has a beneficiary that should not receive an outright distribution, at least not immediately,” says S. Blake Harris, managing attorney at Mile High Estate Planning in Denver. So you may consider creating a testamentary trust for minors if you have young children, or one for a dependent with a disability or an adult child who’s a bit of a spendthrift.
In the case of a testamentary trust for minors, a trustee or guardian would be charged with managing assets on behalf of children named as beneficiaries until they reach legal age or another milestone noted in the trust.
How does a testamentary trust work?
A testamentary trust involves three separate parties:
- A grantor, who creates the trust
- One or more beneficiaries, who receive assets from the trust
- A trustee, who is responsible for managing those assets on behalf of beneficiaries
Creating a testamentary trust is done through a will. The will should specify the name of the grantor, the beneficiaries and the trustee, as well as any successor trustees. It should also spell out which assets are to be transferred to the trust and how those assets should be managed on behalf of the named beneficiaries.
So when does a testamentary trust take effect? Technically, a testamentary trust’s terms cannot be enforced until the grantor dies.
One thing to note is that, unlike many other types of trusts, testamentary trusts are subject to probate. Probate allows for inspection of the will to establish its validity, and this can take time and come with significant costs.
What’s the difference between a testamentary trust vs. living trust?
Living trusts, also called inter vivos trusts, are another type of trust you may consider for estate planning. A living trust can be established in your lifetime and is generally revocable until you pass away. You can, however, establish an irrevocable living trust if you wish the transfer of assets to be permanent.
A living trust can be used to hold the same types of assets as a testamentary trust, and they can be established for the same purposes. There are, however, two key differences:
- Living trusts are not subject to probate the way a testamentary trust is. That’s a plus if you’re hoping to avoid probate when distributing assets to beneficiaries, though it doesn’t necessarily mean avoiding inheritance or estate taxes.
- The second difference has to do with how these types of trusts are funded, i.e., when assets are transferred to the trust. With a testamentary trust, the transfer of assets doesn’t occur until the grantor dies. A living trust, however, would need to be funded during the grantor’s lifetime. But the grantor could name themselves as trustee, allowing them to have continued control of the assets.
Advantages and disadvantages of a testamentary trust
Advantages of a testamentary trust
- Estate planning control: A testamentary trust gives you control over how assets are to be distributed once you pass away. That may be important to you if you have minor children for whom you want to provide financially, or if you want to ensure your favorite charities receive a share of your assets.
- Asset protection: A testamentary trust can be used to shield assets inherited by beneficiaries from creditors. So if you leave assets to your adult children, for example, creditors couldn’t attach them to collect on outstanding debts.
- Cost-effective: Testamentary trusts may be less expensive to create initially, compared to other types of trusts. Though you do have to account for ongoing costs, such as trustee fees.
- Asset retention: Because a testamentary trust doesn’t take effect until you die, no assets are transferred to the trust during your lifetime. That means you maintain control of those assets as long as you’re living.
Disadvantages of a testamentary trust
- Ongoing costs: As mentioned, testamentary trusts must go through probate. Depending on your state’s probate laws, and how long the trustee must act for the trust, testamentary trusts may be subject to regular probate inspections. The cost of court fees associated with this process could make a testamentary trust expensive to maintain.
- Less privacy: Assets that are excluded from probate don’t become a matter of public record. Because a testamentary trust must be probated, anyone can review its terms if wills are treated as public records under state law.
- Difficult to change: Once a testamentary trust is created through a will, changing it can be difficult. The only way to change it may be to destroy the will that created it and draft an entirely new one, which can be time-consuming and potentially costly.
- Taxation: One reason for considering any type of trust in estate planning is to minimize estate and inheritance taxes. Since testamentary trusts transfer property after your lifetime, any tax benefit in these areas is muted. Beneficiaries would also be subject to income and capital gains taxes on trust income retained in the trust and not paid to the beneficiary during the year.
How to set up a testamentary trust
If you’d like to create a testamentary trust, consider these steps:
- Decide whether to do it yourself or hire a trusted estate planning attorney to help: You can create a will yourself for very low cost, with a generic online template that can set you back as little as $10, according to Legal Zoom. But if you have a more complex estate, it may be worth it to pay an attorney’s fee to ensure your testamentary trust is valid. In that case, you may pay closer to $600, or more, to draft a will that includes a testamentary trust.
- Choose beneficiaries and a trustee: Once you’ve decided how you’ll create a testamentary trust, the next step is choosing whom to name as beneficiaries and selecting a trustee and one or more successor trustees.
- Decide which assets should be transferred to the trust: Since this happens only when you die, your trustee is responsible for ensuring the proper transfer of assets. The trustee would also handle the probate process.
While a testamentary trust can yield benefits for estate planning, it may not be right for everyone. You might consider talking to an estate attorney or financial advisor about where this type of trust may fit into your own estate plan.
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