What Is a Testamentary Trust?

What Is a Testamentary Trust?

Let me explain what a testamentary trust is. It's a trust you set up through instructions in your last will and testament. Essentially, a trust is a fiduciary setup where a trustee, acting as a third party, handles assets for the beneficiaries.

In your will, you can include directions to create this trust, allowing the trustee to distribute your assets to the beneficiaries you've named. Remember, the trust doesn't come into existence until after you've passed away. Your will might even establish multiple such trusts.

These trusts fit into your overall wealth management plan by providing clear instructions for asset distribution from your estate. That said, you should weigh the pros and cons before adding one to your will. In Canada, testamentary trusts are one of two legal trust types, the other being the inter-vivos trust.

Understanding a Testamentary Trust

You create a testamentary trust to manage a deceased person's assets for their beneficiaries. It also serves to cut down on estate taxes and guarantee professional handling of those assets.

The trust doesn't exist while you're alive; it's part of the instructions in your will, to be carried out by your chosen executor after you die. Only then are your assets moved into the trust.

You can structure it so assets go to beneficiaries only when conditions are met. For instance, a child's educational expenses might be covered until they turn 25, then the rest is paid out.

It can also handle charitable distributions as per your wishes.

Requirements for a Testamentary Trust

Typically, three parties are involved: the grantor (that's you, creating the trust), the trustee who manages the assets, and the beneficiaries named in the will. You set it up to activate upon your death.

The trust is a provision in your will that names the executor and directs them to establish it. But it doesn't happen right away—your will must go through probate, the court process to validate it and the executor.

Important note: the trust lasts until a specified event, like a child turning 21.

After probate, the trust is set up, and the executor transfers assets into it. The trustee manages them until the trust ends, then beneficiaries get the assets. Expiration often ties to events like reaching a certain age or graduating college. The court might oversee it periodically.

You can pick anyone as trustee, but they can decline. If so, the court appoints one, or a relative might step in.

Testamentary Trust vs. Living Trust

A testamentary trust, as I've described, comes from your will and starts after death, once the executor settles the estate.

In contrast, a living trust is set up while you're alive, with a trustee managing assets for beneficiaries right away.

Though you outline the testamentary trust while living, it only forms post-death, limiting your involvement. A living trust (or inter-vivos) lets you participate since you're around when it's created.

Living trusts can be revocable (changeable) or irrevocable (fixed). Testamentary trusts are usually irrevocable because you can't alter them after death.

Advantages and Disadvantages of a Testamentary Trust

Testamentary trusts have their upsides and downsides. They can be a solid estate planning tool, but it depends on your situation.

Advantages

If you have young children, this trust ensures assets go to them only after a milestone, like turning 18, if you die early.

You can modify the plans anytime while alive by changing your will. Once created after death, it's irrevocable.

For those short on funds, it's cheaper than a living trust since costs come from the estate post-death. You can always switch to a living trust later if your finances improve.

Disadvantages

The big drawback is it doesn't avoid probate, so the executor must go through court to validate and distribute assets, which can take months.

Beneficiaries might wait weeks or months for assets. Plus, everything becomes public record through probate.

There's risk of errors or unclear instructions in the will, leading to the trust not reflecting your exact wishes, unlike a living trust set up while you're alive.

How to Create a Testamentary Trust

You can find online resources for this, but it's complex, and mistakes could lead to legal issues. I recommend working with a lawyer to ensure it complies with your state's rules and properly distributes assets.

To set it up, choose your trustee and beneficiaries, decide which assets go in, and specify disbursement terms. Include this in your will. After you pass, it goes through probate, then the trust is created and assets disbursed.

Example of a Testamentary Trust

Suppose you set one up where a beneficiary gets half the assets at 35 and the rest at 55. For $200,000, this provides oversight to avoid rash spending young.

Another case: a trust for a spouse on Medicaid, covering non-covered medical costs without affecting eligibility.

What Is a Testamentary Document?

These are legal docs in estate planning that dictate asset distribution and other wishes, like wills, codicils, business contracts, or pour-over wills.

Why Do You Need a Letter of Testamentary?

It's issued by probate court, giving the executor legal power to handle the estate, needed with the death certificate for financial transactions.

Do I Need a Lawyer to Get a Letter of Testamentary?

Often yes, especially with multiple beneficiaries, but it varies—if you're the executor, you might not always need one.

The Bottom Line

A testamentary trust is a useful tool for ensuring beneficiaries get your assets as intended after death. But with various trust options, consult an attorney or financial expert to pick the right one for you.