Updated: December 30, 2022
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.
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.
A Separate Share Trust is similar to the standard testamentary trust, but with each child’s trust having different assets and features specific to their situation and needs.
Because receiving different amounts of your assets can create resentment among siblings, especially if created in your will when each child can learn what the other is inheriting, 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 also 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/separate 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.
It is less expensive to set-up and manage a single pot trust than having multiple individual trusts when you have more than one child.
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. Rules for discretionary trusts vary by state, so it is important to consult a professional.
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 created using a discretionary deed of trust and usually chosen 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, gambling or drug habit, personal or professional creditors, lawsuits, divorced spouses, predator’s/scams, etc.
A trustee is chosen who can name beneficiaries if they are otherwise unspecified and has complete control to manage the finances until a pre-specified time, until the beneficiaries are capable of managing them as determined by the trustee, or the lifetime of the beneficiary.
A spendthrift trust may be allowed in some states. It can be either and irrevocable living trust that can be used while you are alive and after your death when it becomes testamentary or a testamentary trust created in your will. It is specifically created to protect the assets of a beneficiary from themselves. These are typically people that:
While a spendthrift trust can protect the trust’s assets from creditors:
The spendthrift trust is most effective if it is also a discretionary trust, and 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, frivolous lawsuits, and dishonest business partners. 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, such as taxes.
Being the trustee of a spendthrift trust can be very stressful and often involves very difficult decisions, so take care with who you choose and leave detailed instructions that could ease the burden. 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.
A dynasty trust is an irrevocable long-term trust that can pass wealth from generation to generation. As long as the trust exists, there are no estate, gift, and generation-skipping taxes when the trust grows and is used by the next generation of beneficiaries.
This is possible because the trust is perpetually held under the control of a trustee and is never transferred to another owner.
You can take advantage of the estate tax/generation-skipping tax exemption, $12.920,000 in 2023 ($25,840,000 for married couples), when creating the trust.
Subsequent beneficiaries have access to the funds as laid out in the trust document, with the goal of keeping the trust funded for future generations. Although no further estate taxes are paid, all disbursements from the trust are subject to income taxes.
The major drawbacks to a dynasty trust are:
Dynasty trusts can split into individual trusts for subsequent beneficiaries, but it become unwieldy to manage the growing number of trusts
Most states set a limit for how long a dynasty trust can exist.
Although very much a part of our lives, we often forget about including our pets in our Estate Plan. While animals may not be able to inherit money or property, you can assure they can be cared for after you die or if you can no longer care for them. These pets may include: cats, dogs, birds, turtles, snakes, lizards, hamsters, and similar small animals. You could also set up a pet trust for larger animals, such as a horse.
While you can leave your pet to a beneficiary in your will and include funds to care for them, you may have little control of how they take care of your pet or spend the money. A pet trust can allow you to do both.
The 1990 Uniform Probate Code stated that a trust for the care of your pets can be created in all states, although there is some state-to-state variation. For most states the terms of the trust is for the rest of a given pet’s life. Some limit the duration of the trust to 21 years after your death, others up to 90 years. The trust cannot include provisions to care for other pets your caretaker may acquire.
Like other types of trusts, a pet trust will appoint a trustee. You will also appoint a caretaker, that may be different from the trustee, who will have custody of your pet and be responsible for their day-to-day care. You can also appoint a separate trust protector or enforcer to make sure your wishes are carried out.
Like other personal representatives, it is best to discuss it with them and to choose an alternative.
Consider the number of pets you have, their age, health, standard of living, grooming needs, and other needs when estimating how much to put in the trust. If the amount seems excessive, your family can contest the amount.
There are many other considerations to think about when deciding on the terms of the trust.
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 it must be sufficiently funded. The trustee will need to: