A testamentary trust (a.k.a. will trust) is a type of trust that, like a will, is created to transfer your assets to your beneficiaries according to your wishes after you die. Unlike a will, the trust allows you to add provisions that will specify when and how the assets are distributed by the trustee and/or used by the beneficiaries. A provision can be added to give the trustee some discretion over disbursement that allows them to adapt to changing conditions.
Characteristics of a testamentary trust include:
The trust has its own IRS tax identification number and any income or capital gains tax on the trust’s earnings are paid for by the trust.
A testamentary trust comes with many perks.
A testamentary trust would be planned by you and is usually for your minor children and dependents or family members with disabilities, any of whom may not be able to manage assets. You can create a testamentary trust for anyone. Depending on your needs, there may be multiple testamentary trusts in your will or living trust.
The usual method is to create an identical trust for each beneficiary. If you do not want to create similar individual trusts for each child or need a trust for a specific purpose, there are other trusts to choose from, depending on the person and the situation.
It is possible to create a testamentary trust in either your will or a living trust (rarely). This is done by including the testamentary trust details in your will or a clause in a living trust. You can alter the terms of the testamentary trust while you are alive by updating your living trust, will, or the appropriate codicil.
There are advantages and disadvantages to each.
When Included in Your Will
When Included in a Living Trust
If you do not want to create similar individual trusts for each child or need a trust for a specific purpose, there are a number of other types of testamentary trusts. The predominant differences are the nature of the beneficiary and the goal of the trust.
Separate Share Trust
To create a trust with different features for each child based on need
Two or more children, at least one under 25 years old
To leave entire estate to children and assure youngest gets their share
Adult children inheriting a large sum of money
To control how children use the assets
Irresponsible adult with poor financial management skills
To restrict how beneficiary uses the assets
Special Needs Trust
Person with long-term physical disabilities, psychological conditions, and/or cognitive deficits
To care for disabled person and cover their medical expenses
Generation Skipping Trust
To leave assets to grandchildren directly
To pay for care of your pets
A charity or non-profit organization
Donating to your favorite causes
A Separate Share Trust is similar to the standard testamentary trust, but with each child’s trust having different features specific to their situation and needs.
Because receiving different amounts of your assets can create resentment among siblings, it may be best to discuss it with them beforehand. It is a form of Sprinkling Trust.
A Pot Trust, also called a Family Testamentary Trust, is a trust that can be created if you have two or more children with at least one of them under 25 years old and you are leaving your entire estate to your children. It is a form of Sprinkling Trust.
The Pot Trust is a single trust that includes all of your children and it gives the trustee discretion over how to spend money on each child. It precludes the creation of individual trusts for each child.
A Pot Trust typically ends when the youngest child reaches the age of majority (18 or 21, depending on the state) and is split evenly among them.
A discretionary trust may be necessary when you are concerned about how a beneficiary will use their trust assets. The trust is basically a detailed plan for how the inheritance is used. To protect the assets from the beneficiary, the trust will have a designated trustee other than the beneficiary.
You can consider a standard testamentary trust created for minors to be a discretionary trust since minors cannot manage financial interests. In this case, you need the trustee or conservator to use your instructions and their discretion to manage the trust for them and use it to provide for their needs.
A discretionary trust is usually created for a spouse or adult children inheriting a large sum of money.
This is typically done to protect assets from a beneficiary’s poor money-management skills, extravagant spending habits, a gambling or drug habit, personal or professional creditors, lawsuits, divorced spouses, preditors/scams, etc.
A trustee is named who has complete control to manage the finances until a pre-specified time or until the beneficiaries are capable of managing them as determined by the trustee.
A spendthrift trust may be allowed in some states. It is a trust that can be used while you are alive or after your death. It is specifically created to protect the assets of a beneficiary from themselves. These are typically people that:
The spendthrift trust is a form of discretionary trust, since the beneficiary has no right to the funds and can’t spend it before they actually receive it. Although the trust protects the portion of the inheritance that remains in it, the money that the beneficiary has received is available to creditors and others.
It can be a long-term trust and usually exists until the beneficiary becomes financially responsible enough to manage their inheritance responsibly. This may be a predetermined age that you dictate in the trust or at the discretion of the trustee. It may exist for their children to inherit if the beneficiary never becomes responsible enough.
The trust names an independent trustee to manage the trust to avoid assets being squandered, used unwisely, or claimed by creditors. In addition to a spendthrift provision, such as No part of the income or principal of this trust shall be subject to anticipation, alienation, or assignment by any beneficiary, other provisions you could add to the trust may vary by state and include:
Spendthrift trusts cannot deny payment for many kinds of obligations, such as child support, alimony, and debts incurred for necessities of life such as food or shelter. Assets may not be protected from government claims.
Being the trustee of a spendthrift trust can be very stressful and often involves very difficult decisions, so take care with who you choose. Since the trust must be carefully tailored to the individuals involved and the spendthrift provision must be carefully worded, it is best to seek professional help.
Preparing to create a testamentary trust is similar to a living trust and involves finding all your assets and making decisions about the type of trust, trustee, and specific details of its contents.
Although you will not be the person to create a testamentary trust, you must put all of the details necessary for your executor to do so in your will or in a living trust for the trustee who will settle it after your death.
To create a testamentary trust, your trustee will need to have a viable document called a Trust Agreement, Deed of Trust, or Trust Deed. There are many forms available and they should choose ones that are appropriate for your state and situation.
Even though a testamentary trust is irrevocable, it can be a laborious undertaking for both the executor or trustee creating it after your death and the trustee managing it.
A testamentary trust is not only a document that must be done correctly, but a dynamic financial investment that must be actively managed.
To have a viable and effective testamentary trust, most of your personal property and other assets that are not jointly owned or do not have designated beneficiaries should be transferred into it by the trustee after you die. The assets should be designated as owned by either the trust itself or the trustee on behalf of the trust.