What’s a Testamentary Trust and How Do I Create One? | Family Finance
One component of your estate plan may be a testamentary trust, which is a legal document, usually created within a will, that becomes effective at your death.
Directing assets through a testamentary trust allows benefactors a degree of posthumous supervision over how their assets are disbursed. “It’s kind of a way to maintain control after you’re gone,” says Jennifer Abelaj, senior counsel for Davidoff Hutcher & Citron LLP in New York City.
A common reason to create a testamentary trust is to provide for your children after your death. For example, if you still have young kids, you could design how your assets are paid out, giving your offspring one-third when they turn 18, another third at age 25 and the final third at age 35. Another reason to create one would be to assist with Medicaid planning for an heir, Abelaj says.
Want to know more? Here’s what to know about testamentary trusts.
What Is a Testamentary Trust?
A testamentary trust is a legal document that is created as part of your will and springs into effect after your death. It holds property for your heirs’ benefit.
This trust comes into effect when three criteria are met, Abelaj says. Those criteria are: the testator has died, the will goes through probate and the terms of the trust are still relevant (for example, the heirs are still younger than the ages specified in the document).
What’s the Difference Between a Testamentary Trust and Living Trust?
Testamentary trusts differ from living trusts, which go into effect during the grantor’s life. One key purpose of a living trust is to allow assets within the trust to avoid the legal proceedings associated with administering the will, called probate.
Because assets are transferred to the testamentary trust at your death through your will, they are subject to probate proceedings, which may cause delays and make the details of the assets public.
A living trust can be revocable – meaning it can be changed at any time – or irrevocable – meaning it can’t be changed once it’s finalized. A testamentary trust can be tweaked up until the creator’s death.
Advantages and Disadvantages of a Testamentary Trust
One advantage of a testamentary trust is that it allows the creator to dictate how their money is disbursed at their death. But it’s not the right estate-planning tool for everyone.
Very high-net-worth individuals may choose to use other estate-planning strategies, such as living trusts, which can be more effective for dodging estate tax and probate. But for families with more moderate assets, a testamentary trust may do the trick, providing them with some control over inheritance disbursement.
A testamentary trust is often used when the creator has minor children and wants to provide some financial oversight of the assets if both parents die while the kids are relatively young, says Jennifer Guimond-Quigley, an attorney in Chicago. It can arrange management of those assets by a guardian, called a trustee.
For example, if you pass away, leaving your child $100,000 in assets, your testamentary trust could ensure that the entire amount doesn’t go to Junior when he turns 18. “You might not want to give them enough money to buy five Ferraris,” Abelaj says.
Instead, you could have some of the money disbursed when they’re age 25. The second chunk could be disbursed at age 30, and the third could hit their accounts at age 35. If Junior wastes the money received at age 25, then he has two more opportunities to get it right. And at those later ages, he may be more likely to spend his inheritance on wise purchases such as graduate school or a down payment on a house.
Another use for testamentary trust is Medicaid planning, Abelaj says. While the exact strategy will depend on your state, generally, if you have a beneficiary who requires Medicaid government benefits, a supplemental needs trust or Medicaid trust can help the beneficiary afford needed expenses without disqualifying them from those benefits. Remember: Medicaid benefits are available to folks who own few countable assets.
How to Set Up a Testamentary Trust
This document typically needs to be created with an estate lawyer. “You start with your attorney,” Abelaj says. “This is not something to do on LegalZoom because the language is very specific.” Often, it’s drafted at the same time as your will for a flat fee or an hourly charge.
Don’t Neglect Your Beneficiary Designations
You can create the world’s strongest testamentary trust, but if your beneficiary designations aren’t updated on accounts such as your 401(k) or life insurance policies, it won’t matter.
The beneficiaries listed on those kinds of accounts overshadow what’s written in your will, so make sure to designate the trust as a beneficiary. If you don’t, the assets will bypass the trust and be paid out according to the account’s terms.
If you’re looking for how to name the trust on your accounts, contact your account administrator. “First you’d look to the financial institution itself,” Guimond-Quigley says. In the absence of canned or standard language, the primary beneficiary would be something like “the trustee of the testamentary trust established under my last will and testament dated on X date,” she says.