Testamentary trusts are created by a settlor's will. A settlor's property is therefore transferred into the trust when the settlor dies. The terms of the trust are detailed in the will. Testamentary trusts allow for a substantial level of control over distribution of assets to beneficiaries and carry significant tax advantages.
Living trusts (inter vivos trusts) avoid probate, but testamentary trusts do not.
Unlike an inter vivos trust, a testamentary trust does not take effect until the trust maker’s death, at which point it becomes irrevocable. Since it does not take effect during the settlor’s lifetime, he or she is free to make changes to the trust up until death.
When the settlor dies, all or part of his or her assets are distributed to beneficiaries through testamentary trusts. While the trusts will be taxed as a whole, the beneficiaries of the individual trusts will not be taxed for the devise.
Testamentary trusts are most frequently used to leave money to the settlor’s children via a will. Since minors may be too young to effectively manage substantial property immediately, a testamentary trust allows the settlor to leave a gift to a child and also to name a trusted guardian as the gift’s trustee. The trustee manages the trust until the minor becomes old enough to manage the property him or herself. Generally, the document indicates a certain event, such as when the child graduates college or turns 25, at which point the trust expires and the beneficiary can take control of the trust property.
Like all other trusts, a testamentary trust assigns a trustee to manage distribution of the trust’s assets. While sometimes the distribution method will be left to the discretion of the trustee, the trust often will carry specific instructions. The settlor must take care to choose a trustee who is knowledgeable and trustworthy because he has a significant degree of control as to how the trust property is used.
The trustee to a testamentary trust must act as a trustee until the trust ends. Since some people will not wish to or be able to take this time-consuming role, the settlor should choose a backup trustee to avoid the court from having to appoint one. It is advisable for the settlor to talk to his or her desired trustee before making the choice.
While the primary purpose of most living trusts is to avoid probate, testamentary trusts, unlike living trusts, do not avoid probate. A will must go through probate before the testamentary trust is created. The executor will probate the will and create the trust in the process. Depending on the number of years for which the trustee must act for a testamentary trust, he or she will need to go to probate court and have the trust examined on a regular basis. Thus, testamentary trusts can end up costing more in legal fees than revocable living wills. The trustee may also require legal advice on how to administer the trust, which can take legal fees from the trust amount. Thus, while testamentary trusts are relatively inexpensive to create, they may become costly once they take effect.
When devising a testamentary trust, you might consider future legal fees involving the trustee’s mandatory appearances in probate court and the fees that they may incur when seeking legal advice on the matter.