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The benefits and disadvantages of testamentary trusts

by Legacy Plan
September 7, 2023

When it comes to estate planning, there's no one-size-fits-all approach. One crucial decision you may face is whether to utilize a testamentary trust or a revocable living trust. A testamentary trust is created upon the death of the grantor and is generally part of a person’s will. It does not exist during the grantor's lifetime and is irrevocable after the grantor's death. In contrast, a revocable living trust exists during the grantor's lifetime and can be changed or revoked at any time before the grantor’s death. It provides more immediate control over the assets and avoids probate.

Both trust options have distinct features, advantages and disadvantages.

What is a testamentary trust?

A testamentary trust is a type of trust that is created by a person's last will and testament and comes into existence only upon the death of the testator (the person who made the will). Unlike a living trust, which is established and operates during the lifetime of the grantor (the person creating the trust), a testamentary trust is activated only after the grantor has died and the will has gone through probate, the legal process that validates a will and administers the deceased's estate.

Because a testamentary trust is part of the will, it can be changed or revoked at any time during the testator's lifetime, as long as the testator is mentally competent.

The testamentary trust is governed by the terms outlined in the will, including the appointment of a trustee who will manage the assets in the trust and distribute them according to the stipulations in the will. These trusts are commonly used to manage assets on behalf of minor children, incapacitated or institutionalized adults or other beneficiaries who may not be able to responsibly manage assets on their own. The trust could specify, for instance, that the beneficiary will only receive their inheritance at a certain age or upon meeting certain conditions or limitations.

This can be particularly advantageous when dealing with beneficiaries who may require special attention due to factors such as age, financial immaturity or special needs circumstances. By establishing specific guidelines within the testamentary trust, individuals can ensure that their legacy supports and protects those they care about most and they can retain control over how their assets are managed and distributed after they pass away.

By appointing a trustee and including specific instructions within this type of trust arrangement, one can ensure that beneficiaries receive support tailored to their unique needs.

What are the advantages of a testamentary trust?

two people discussing a trust with a model home and a bag with a dollar sign on the table

Testamentary trusts can provide control over asset distribution, asset protection, tax efficiency, special needs provisions and overall flexibility to be easily amended before the grantor’s death.

One of the main advantages of a testamentary trust is the ability to control how your assets will be distributed after your death. This can be particularly useful for individuals who have minor children or beneficiaries with special needs or who are otherwise incapable of managing their financial affairs responsibly.

The trust allows for staggered or conditional distributions to beneficiaries. For example, you can stipulate that your children receive portions of their inheritance at certain ages or milestones, such as graduating from college or getting married, rather than receiving a lump sum all at once.

Another crucial advantage of a testamentary trust is its ability to provide asset protection. By placing assets in a trust rather than directly transferring them to beneficiaries, the testator shields those assets from potential creditors or legal claims made against the beneficiaries themselves. Assets held in a testamentary trust are generally not accessible to creditors of the beneficiaries. This can protect the inheritance from being drained by debts, lawsuits or divorce settlements.

Are there tax considerations with a testamentary trust?

Testamentary trusts are usually subject to the same tax filing and reporting requirements as other types of trusts, which can create administrative burdens. Furthermore, tax laws are subject to change, so what may be a tax advantage today could be eliminated or reduced by future legislation. As with all tax-related matters, the complexities and opportunities for savings vary by individual circumstances, and expert advice should be sought for personalized planning.

How is a testamentary trust used for beneficiaries with special needs?

a special needs child recieving care

A testamentary trust can be specifically designed to provide support to a beneficiary with special needs, often referred to as a "special needs trust" or "supplemental needs trust." This specialized type of trust can allow the beneficiary to benefit from the assets in the trust without jeopardizing their eligibility for governmental assistance programs like Medicaid, Supplemental Security Income (SSI) or other means-tested benefits.

Here are some key features of how such a trust can be designed:

  • Discretionary distributions: The trustee has discretion over how the funds are distributed for the benefit of the special needs beneficiary. Usually, funds are not given directly to the beneficiary but are instead used to pay for services and items that are not covered by public assistance, such as education, recreation, therapies or even vacations.

  • No direct control: The beneficiary typically has no direct control over or access to the funds in the trust. This is crucial for ensuring that the assets in the trust are not counted when determining eligibility for government aid.

  • Payback provisions: Some jurisdictions may require that the trust include a "payback" provision, which means that upon the death of the beneficiary, the state is reimbursed for the cost of the medical care provided to the beneficiary during their lifetime, from what remains in the trust.

  • Spendthrift clause: A spendthrift clause can protect the assets in the trust from creditors and legal judgments against the beneficiary. This can be particularly important if the beneficiary is not capable of managing money or legal affairs on their own.

  • Co-trustees or advisory committee: Sometimes, it's advisable to have co-trustees or an advisory committee to assist the trustee in making decisions related to the special needs of the beneficiary. This can include medical professionals or caregivers who are familiar with the beneficiary’s specific needs.

  • Funding mechanisms: The trust should be adequately funded to meet the beneficiary's needs, and it may also have provisions that allow for additional funds to be added to the trust after the testator’s death, through mechanisms like life insurance payouts or gifts.

  • Periodic reviews: The trust document should allow for periodic reviews to adjust for changes in laws and the beneficiary’s needs. This is especially important given that laws affecting public benefits can change, impacting the effectiveness of the trust.

By carefully designing a testamentary special needs trust, you can provide for a loved one in a way that improves their quality of life without compromising their access to vital public benefits. Given the complexities involved, it’s essential to consult professionals who specialize in estate planning and special needs trusts to ensure that the trust serves its intended purpose effectively.

What are the disadvantages of a testamentary trust?

While testamentary trusts offer numerous benefits, it is essential to also consider the potential disadvantages associated with this estate planning tool. One key disadvantage of a testamentary trust is that it involves a more complex and time-consuming process compared to other estate planning options. Since a testamentary trust is created within a will and only becomes effective upon the testator's death, the will must go through probate before the trust can be established.

Probate proceedings can often be lengthy, causing delays in distributing assets to beneficiaries and potentially increasing administrative costs. In addition to potential delays, another disadvantage of a testamentary trust is its lack of privacy.

Unlike living trusts that are created during an individual's lifetime, testamentary trusts become part of public record during probate proceedings. This means that anyone who has access to public records can review the terms and conditions outlined in the trust document, including information about beneficiaries and their inheritances.

For individuals who value confidentiality or wish to maintain family privacy even after their passing, this lack of discretion may be seen as a significant drawback. Also, since testamentary trusts are often subject to court supervision during probate proceedings, they may be subject to additional fees and costs associated with legal representation or court-appointed trustees.

This additional layer of oversight can lead to increased expenses for managing the trust's assets and ensuring compliance with legal requirements. While testamentary trusts provide flexibility in determining how assets are distributed over time or under certain conditions, they lack some advantages offered by living trusts.

Living trusts allow individuals to avoid probate altogether and manage their assets during their lifetime if they become incapacitated — a benefit not available with a testamentary trust. While testamentary trusts offer valuable estate planning advantages such as asset protection for beneficiaries or providing for special needs dependents, it is essential to recognize the potential disadvantages associated with this type of trust.

These include the complex and time-consuming probate process, limited privacy, potential increased costs and the lack of flexibility compared to living trusts. Understanding these drawbacks is crucial in determining whether a testamentary trust aligns with an individual's unique estate planning goals and requirements.

Conclusion

A testamentary trust can be a valuable tool in estate planning, providing individuals with the ability to protect and control their assets even after they have passed away. A testamentary trust allows for the orderly distribution of assets and offers beneficiaries certain protections that they may not have otherwise had. By establishing a trust through explicit instructions in a will, individuals can ensure that their wishes are carried out while safeguarding their beneficiaries' inheritance from potential mismanagement or external threats.

Moreover, testamentary trusts provide added flexibility by allowing for specific conditions or provisions to be included based on the unique needs of each beneficiary. However, it is also crucial to consider some of the drawbacks associated with testamentary trusts.

One significant disadvantage is the cost involved in setting up and administering these types of trusts. The involvement of legal professionals and ongoing administrative requirements can result in additional expenses compared to more straightforward inheritance arrangements.

Additionally, as testamentary trusts are subject to probate court proceedings upon the individual's death, there may be delays in distributing assets to beneficiaries. Despite these challenges, it is important to recognize that each individual's circumstances are unique when it comes to estate planning.

While some may find testamentary trusts highly beneficial due to complex family dynamics or special needs beneficiaries requiring long-term financial support and protection; others might find simpler inheritance arrangements sufficient for achieving their goals. Incorporating a testamentary trust into your overall estate plan should be carefully considered based on your specific circumstances and objectives.

Utilizing this legal instrument can provide peace of mind knowing that your assets are protected and distributed according to your wishes while offering added benefits such as asset management for special needs beneficiaries or protecting legacies for future generations. By consulting with estate planning professionals, you can make informed decisions and ensure that your estate plan aligns with your long-term goals, leaving a lasting legacy for your loved ones.

How do I create an estate plan?

There are numerous options and scenarios to consider when developing an estate plan that protects your legacy and achieves your objectives, and important decisions should be made with the advice of qualified lawyers and financial experts. Membership with Legacy Assurance Plan provides members with valuable resources and guidance to develop comprehensive estate plans that take life's contingencies into consideration and leave a positive impact for generations to come. Legacy Assurance Plan members also receive peace of mind that a team of trusted, experienced professionals will assist them in developing legal, financial and tax strategies that will meet their needs today and for years to come through periodic reviews.

This article is published by Legacy Assurance Plan and is intended for general informational purposes only. Some information may not apply to your situation. It does not, nor is it intended, to constitute legal advice. You should consult with an attorney regarding any specific questions about probate, living probate or other estate planning matters. Legacy Assurance Plan is an estate planning services company and is not a lawyer or law firm and is not engaged in the practice of law. For more information about this and other estate planning matters visit our website at legacyassuranceplan.com.

Phone - 844.445.3422
Email - info@legacyassuranceplan.com
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