What Are the Benefits of Having a Testamentary Trust?

Pen atop an estate planning document awaiting a signature.A trust is a kind of legal arrangement where a third party holds legal title to assets or property for the benefit of someone else. The individual creating the trust is the "testator." The person or entity named to carry out the testator's instructions is the "trustee."

There are various types of trusts that people may create as part of their estate plan to suit their particular situation.

What Is a Testamentary Trust?

With a testamentary trust, an individual provides a trustee with instructions on how to distribute their property after they have died. A testamentary trust is a part of the testator’s last will and testament. In part because this type of trust doesn't become effective until the testator dies, it can offer a number of benefits.

Wealth Management and Asset Protection

For one, testamentary trusts help with overall wealth management by protecting the testator’s assets after their death.

For example, perhaps you wish to name your minor grandchildren as the beneficiaries of your estate. However, you have some concerns about their capacity to spend the assets wisely at a young age.

As the testator, you can ensure that these minors receive assets only after they have reached a specified age. This may help reduce the chance of them wasting or misusing the assets you pass down to them. (Whitney Houston was among the celebrities who had put this type of trust in place as part of their estate plan.)

At the same time, assets in a testamentary trust are not accessible to creditors. As part of your trust instructions, you may have named a loved one who, for instance, has fallen into serious debt. Because the trust owns the assets and not the beneficiary, creditors cannot access them.

You Can Change the Trust Terms During Your Lifetime

As mentioned above, the terms of a testamentary trust do not go into effect until after the testator’s death. This gives the testator some level of flexibility with the trust and control over the assets within it during their lifetime. If your needs change or you gain or lose assets, you can therefore return to the trust and adjust it accordingly. The malleable nature of this type of trust may prove helpful if you have more children or your marital status changes.

Tax Benefits of Testamentary Trusts

Testamentary trusts can also have several tax benefits.

For example, if you place assets into this type of trust, your beneficiaries will not have to pay taxes on the income generated – and distributed – from the trust (otherwise known as double taxation). However, note that if the trust earns more than $600 in income per year, the beneficiaries may be required to file a tax return for that year.

There may also be capital gains tax benefits to placing assets into a testamentary trust. Normally, a person who sells an asset for profit may have to pay a capital gains tax on the income generated from the sale. However, if legal ownership of an asset is transferred from one person to another through a testamentary trust, the capital gain received by the beneficiary may be disregarded.

Because taxation rules vary by state, be sure to consult with an estate planning attorney. If you are considering setting up a testamentary trust, a professional can help you understand how your particular state would handle the taxation of different trusts.

A Note on Probate

Keep in mind, however, that testamentary trusts do not avoid probate. Probate is the legal process that courts follow to review your assets and ensure your last will and testament is valid. Through this process, the court may:

  • confirm that the assets claimed by the estate are in fact owned by the testator,
  • officially appoint the executor of the estate,
  • guarantee that any creditors making claims against the estate have valid claims, and
  • see that the appropriate heirs receive the assets or property as the deceased intended.

This means that your loved ones may not avoid estate taxes even if you have placed assets into a testamentary trust.

Be sure to speak to a qualified tax professional or accountant to answer any questions you have about your tax obligations.

Protect Your Surviving Spouse

To qualify for Medicaid in most states, applicants must have no more than $2,000 in "countable" assets. Imagine that you passed away and your spouse later needed to apply for this public benefit to cover nursing home care. They may face a situation where they have to spend most of their assets before they became eligible for Medicaid coverage.

A testamentary trust could have provided a solution to this kind of dilemma. For instance, you may wish to place assets into this type of trust for the benefit of your surviving spouse. Because assets will belong to the trust (rather than your spouse) upon your death, Medicaid would not consider them "countable."

Easy to Create

Testamentary trusts may be the easiest estate planning tool to create aside from a last will and testament. You can include it as part of your will-drafting process. Or, you can easily add it to your estate plan at a later date with the help of your attorney.

Connect With an Estate Planning Attorney

Consult with a qualified estate planning attorney in your area for more information. They will have the expertise needed to help you navigate the complexities of different options for trusts. Learn more about other common types of trusts.

Contact us

Questions? Contact us at Chambliss, Bahner & Stophel, P.C.

Chambliss, Bahner & Stophel, P.C.
Liberty Tower | Suite 1700 | 605 Chestnut Street | Chattanooga , TN 37450
Phone: 423.756.3000