What Is a Testamentary Trust and How Do I Create One?
A testamentary trust can control your assets after death, but there may be a better option available, experts say.
By Maryalene LaPonsie
Edited by Jennifer Ortiz
July 14, 2022
Not everyone wants to leave heirs with unfettered access to the wealth they've accumulated over the course of a lifetime. Some people want to put restrictions on when or how money is used. Others hope to protect an inheritance from being scooped up by creditors or diverted away from children by a second wife or husband.
In all these cases, a testamentary trust can be a useful estate planning tool. What's more, it makes it possible to leave assets to minor children who may not be able to legally possess or manage them on their own.
Keep reading to learn all about testamentary trusts, how to set one up and why some experts say they have fallen out of favor.
What Is a Testamentary Trust?
Trusts are created to hold assets, and money in a trust is managed according to the wishes of the person who created it.
"A testamentary trust is created in a last will and testament," explains Neil V. Carbone, an estate planning attorney and partner with Farrell Fritz in New York City.
The trust doesn't come into existence until after a person dies and the will has been validated by probate court. Once the trust has been created, a person's assets are placed into it and then distributed as designated by its legal documentation.
What's the Difference Between a Testamentary Trust and a Living Trust?
Sometimes called a revocable trust, a living trust is created prior to someone's death.
"A revocable trust is created outside of probate," says Patrick Simasko, elder law attorney and wealth preservation specialist with Simasko Law in Mount Clemens, Michigan. That means heirs don't have to go through the court system to receive assets from a living trust. Instead, a trustee can distribute funds directly to beneficiaries.
Both testamentary trusts and living trusts are used for estate planning, but Simasko says a living trust is more flexible and can have lower long-term costs.
That's because living trusts are not only created outside probate but managed outside the court system as well. Meanwhile, testamentary trusts are administered through probate for as long as they are in effect.
Advantages and Disadvantages of a Testamentary Trust
A testamentary trust is often used to manage money for minor children, but it can protect assets in other situations too. For instance, if you are worried that your adult child might get divorced and don't want the inheritance to get split in the proceedings, a trust may be one way to do that.
"The good part about it is that there is a lot more court oversight," Simasko says. The bad part is court oversight doesn't come cheap.
Simasko uses the example of having a testamentary trust to manage money for an 8-year-old beneficiary until age 25. "That means 17 years of probate, and you know how expensive lawyers are." As a result, while testamentary trusts may be less expensive than living trusts to set up, they could cost more in the long run.
Going through probate court can also mean a loss of privacy. "Anything filed in probate becomes public record," says Donald Kress, senior vice president and chairman of the trust administrative committee for Coral Gables Trust Company. "Any snoopy person can see the details."
For these reasons, many estate planning experts prefer living trusts, which can provide the same benefits of testamentary trusts while, at the same time, avoiding probate.
The only time a testamentary trust may have an advantage over a living trust is if someone involved in the estate is prone to taking legal action, in which case court management may be preferable.
How to Set Up a Testamentary Trust
There are websites that provide templates for people to create their own trust documents, but experts urge caution.
"The problem is people don't understand all the ins and outs of how these documents work," Kress says. What's more, if assets aren't titled correctly, they might be excluded from the trust, defeating the whole purpose of creating one.
Do-it-yourself forms could also be more likely to face legal challenges. "These documents have been fodder for a lot of estate court litigation," Carbone notes.
Having an attorney draw up will and trust documents will ensure they meet your state's requirements and are written in such a way to ensure your assets are distributed according to your wishes. Depending on your state and attorney, a testamentary trust could cost around $1,700 to create, Simasko says.
What Happens After You Make a Testamentary Trust?
Nothing, at first. "The testamentary trust doesn't come into effect until the person dies," Kress says.
At that time, the testamentary trust will be created and assets will be moved into it as stipulated in your will. Then, distributions will occur from the trust as dictated by you.
For instance, a testamentary trust could state that a minor child gets access to all assets at a certain age, or it could be written to provide annual payments rather than a lump sum payout.
Don't Neglect Beneficiary Designations
If you have assets with named beneficiaries or transfer-on-death designations, that money won't go into a trust. "The will is only for things in your name (alone)," Simasko says.
Legally, beneficiary designations trump any provision in a will or trust, so it's important to review this information annually. Otherwise, you run the risk of having your money accidentally end up in the hands of someone who is no longer in your life, such as an ex-spouse.
Life insurance, retirement funds, bank accounts and investments are all examples of the type of assets that can be given to named beneficiaries.
How to Annul a Testamentary Trust
Changing or annulling a testamentary trust while you are alive is simple. All it takes is for you to revise your will.
However, after death, it becomes much more difficult. "Once you're dead, it's irrevocable," Kress says.
There is a process known as decanting a trust, according to Carbone, and that involves distributing or transferring all the assets out of a trust. Rules may vary by state, and there can be limits to when and how this process can occur.
To avoid any confusion among your heirs that could lead to this type of court action after your death, carefully consider the provisions you include in your trust and, if appropriate, communicate them to your loved ones in advance.
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