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Is a Testamentary Trust Right for You?

Is a testamentary trust right for you? by davis law group pc in chesapeake, virginia

Is a Testamentary Trust Right for You?

February 15, 2024 Davis Law Group

Difference Between Wills and Trusts

A will is a document that provides instructions for how to distribute a person’s assets after death. A will only becomes effective upon the testator’s death, so the testator can change his will up until the time of death. (“Testator” is the legal word to describe the author of the will.) A will must go through probate, which is the process by which a court oversees the administration of the estate. The court will recognize a will and appoint an executor who distributes the assets to beneficiaries. Probate is a public process, so information about the estate revealed in probate becomes part of the public record.

A trust, on the other hand, is a legal entity that is generally created by a legal document. The person who creates a trust is called the “settlor.” Upon creation, the trust is empty and must be funded with assets. The settlor must retitle assets to the trust and designate the trust as the beneficiary on various policies, like life insurance and retirement accounts. Some people believe that creating a trust is the only step, so they fail to fund it. An unfunded trust is really no use at all.

A trust is managed by a trustee. The trustee must follow the trust’s directives when making distributions to beneficiaries. Trusts may be revocable (freely changeable) or irrevocable (set in stone). Trusts can be created and operated during a settlor’s lifetime and are often used in estate planning to avoid probate. (Because the trust assets no longer belong to the settlor but rather the trust, they will not go through probate because they are not part of the settlor’s estate.) Trusts generally allow someone to have more control over the distribution of assets during lifetime and after death.

Testamentary Trusts

A testamentary trust is a trust that is created by a will. Because it is created by a will, the trust will only come into existence after the testator has died and the will has been recognized in the probate process. The trust is an entity separate from the estate and will be funded by estate assets. For a testamentary trust to be valid, the intent to make a trust must be clearly spelled out in the will. The testator must identify the trustee, beneficiaries, and the purpose of the trust in the will. The testator should also specify which assets will fund the trust and how distributions should be made to the beneficiaries. A testator may create more than one testamentary trust in a will.

Because the trust only comes into existence after the testator’s death, the terms of a testamentary trust can be changed any time up until death. Once the testator dies, the testamentary trust will be created as an irrevocable trust so that none of the terms may be altered.

Testamentary trusts are often used when people want to adapt their estate plan to take care of minor children. Instead of providing an inheritance to children outright, a testamentary trust may be used to hold the inheritance until the child reaches a certain age or achieves a certain milestone (like graduating from high school or college). In the meantime, the trustee can have the power to make distributions to the child for education, healthcare, or other important costs. This way, the child is taken care of and will not squander an inheritance.

Types of Testamentary Trusts

There are two general types of testamentary trusts: family trusts and separate trusts.

A family trust is a single trust that holds all the designated assets. The trustee can distribute funds to the beneficiaries according to the beneficiaries’ needs. In this type of trust, beneficiaries do not necessarily receive equal distributions but receive distributions according to what they need. Parents usually elect to use this kind of trust if they have a child with special needs or one of their children needs more assistance than the others.

Separate trusts, on the other hand, are trusts set up for each beneficiary. Generally, each beneficiary gets his or her own individual trust that is funded with an equal portion of trust assets. A testator could create separate trusts that are funded in different amounts to still take care of a beneficiary that needs extra assistance, but such a process would be more complicated than creating a family trust and giving the trustee discretion to ensure each beneficiary receives what he or she needs.

Advantages and Disadvantages

An advantage of a testamentary trust is that it allows testators with minor children to ensure that the children are taken care of and receive their inheritance at an appropriate time. Testamentary trusts generally are less expensive to create than a trust that would become active during the settlor’s lifetime but give the same option to create more structure and control over asset distribution than a will.

An added benefit of a testamentary trust is that it can be funded with life insurance proceeds. Life insurance policies can have very large payouts, so instead of giving a large sum directly to a child, the sum can be held in trust until the child turns a certain age or achieves a certain milestone.

However, a testamentary trust does not avoid probate. Some people prefer to avoid court intervention or do not want their assets to become part of a public record. A testamentary trust would not help individuals achieve these goals.

Because the testamentary trust goes through probate, the trustee will need to give regular updates to the probate court. The probate court’s involvement with the testamentary trust will continue until the trust terminates. This may be beneficial for testators who fear litigation by beneficiaries because the court will already be involved. However, continued court involvement can require attorney involvement, which may increase legal fees paid out by the trust. It is also important to remember that all trusts are legal entities and must file their own tax returns.

Is it right for you?

Are you wondering if a testamentary trust might be right for you? The best way to find out is to meet with one of our experienced estate planning attorneys. We can help you determine the right estate planning vehicle for your unique situation and comfort level. Contact Davis Law Group today.