If you are drawing up your will and want to leave money to a minor child, using a testamentary trust is one way to do so. This legal document can also be beneficial in other situations, such as if you want to leave an inheritance to someone but aren’t sure they will use the gift wisely.
Keep reading to learn all about testamentary trusts, how to set one up and why some experts say they have fallen out of favor.
What Is a Testamentary Trust?
Trusts are created to hold assets, and money in a trust is managed according to the wishes of the person who created it.
“A testamentary trust is a trust that is created by one’s will after they die,” explains Paul Holland, trust, estate and tax attorney with Holland Law Offices in Stonington, Connecticut.
Once the trust has been created, a person’s assets are placed into it and then distributed as designated by its legal documentation.
[Read: 10 Steps to Writing a Will.]
What’s the Difference Between a Testamentary Trust and a Living Trust?
Sometimes called a revocable trust, a living trust is created prior to someone’s death.
“A revocable trust is created outside of probate,” says Patrick Simasko, elder law attorney and wealth preservation specialist with Simasko Law in Mount Clemens, Michigan. That means heirs don’t have to go through the court system to receive assets from a living trust. Instead, a trustee can distribute funds directly to beneficiaries.
Both testamentary trusts and living trusts are used for estate planning, but Simasko says a living trust is more flexible and can have lower long-term costs.
That’s because living trusts are not only created outside probate but managed outside the court system as well. Meanwhile, testamentary trusts are administered through probate for as long as they are in effect.
Advantages and Disadvantages of a Testamentary Trust
A testamentary trust is often used to manage money for minor children, but it can protect assets in other situations too. For instance, if you are worried your adult child might get divorced and don’t want the inheritance to get split in the proceedings, a trust may be one way to do that.
“The good part about it is that there is a lot more court oversight,” Simasko says. The bad part is court oversight doesn’t come cheap.
Simasko uses the example of using a testamentary trust to manage money for an 8-year-old beneficiary until age 25. “That means 17 years of probate, and you know how expensive lawyers are.” As a result, while testamentary trusts may be less expensive than living trusts to set up, they could cost more in the long run.
After 27 years of practice, Holland is hard-pressed to think of instances in which a testamentary trust is a better choice than a living trust. “Lawyers like me don’t use testamentary trusts anymore,” he says.
The only time a testamentary trust may have an advantage over a living trust is if someone involved in the estate is prone to taking legal action, in which case court management may be preferable.
[Read: How to Write a Will Online.]
How to Set Up a Testamentary Trust
There are websites that provide templates for people to create their own trust documents, but experts urge caution.
“We tell our clients to absolutely have an attorney draft the documents,” says Gerry Joyce, managing director and national head of trusts and estates at Fiduciary Trust Company International. “Find someone who specializes in trusts and estates.”
Having an attorney draw up will and trust documents will ensure they meet your state’s requirements and are written in such a way to ensure your assets are distributed according to your wishes. Depending on your state and attorney, a testamentary trust could cost around $1,700 to create, Simasko says.
What Happens After You Make a Testamentary Trust?
“Nothing really happens until you pass away,” Joyce says.
At that time, the testamentary trust will be created and assets moved into it as stipulated in your will. Then, distributions will occur from the trust as dictated by you.
For instance, a testamentary trust could state that a minor child gets access to all assets at a certain age, or it could be written to provide annual payments rather than a lump sum payout.
Don’t Neglect Beneficiary Designations
If you have assets with named beneficiaries or transfer-on-death designations, that money won’t go into a trust. “The will is only for things in your name (alone),” Simasko says.
Legally, beneficiary designations trump any provision in a will or trust, so it’s important to review this information annually. Otherwise, you run the risk of having your money accidentally end up in the hands of someone who is no longer in your life, such as an ex-spouse.
Life insurance, retirement funds, bank accounts and investments are all examples of the type of assets that can be given to named beneficiaries.
[Read: How to Save Money for Your Kids.]
How to Annul a Testamentary Trust
Changing or annulling a testamentary trust while you are alive is simple. All it takes is for you to revise your will.
However, after death, it becomes much more difficult. “The testamentary trust requires you to go to the court to make changes,” Joyce says.
That lack of flexibility is one more reason why Joyce and others say people should weigh their options carefully when choosing between a testamentary trust and a living trust.
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What Is a Testamentary Trust and How Do I Create One? originally appeared on usnews.com
Update 07/19/21: This story was published at an earlier date and has been updated with new information.
