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Testamentary Trust vs Living Trust

Sep 16, 2022 | Financial Trust Legal Blogs | Elder Law P.A

What are the differences with regard to a testamentary trust vs living trust? A testamentary trust is a trust that is created according to the directions contained in the last Will and Testament. It is not a standalone document; it is included in the Last Will and Testament of a person. A living trust is more like a custodian relationship that permits a trustee (usually a third party) to manage the assets on behalf of the trust beneficiaries and trustor. It is a separate and standalone document.

In most cases, an individual’s will can include instructions to create a testamentary trust so that the trustees can distribute the individual’s estate to the beneficiaries as outlined in the will. The important thing to understand is that a testamentary trust is only created after the individual has passed away. In addition, a will may have more than one testamentary trust.

A testamentary trust is a useful tool as part of a wealth management strategy as it can provide instructions for the distribution of assets belonging to the decedent after death. However, a testamentary trust has both pros and cons which one should consider before creating such a trust in a will.

BASICS OF A TESTAMENTARY TRUST

There are several reasons why a testamentary trust vs. living trust may be created, and they include the following:

  1. Manage the assets of the decedent on behalf of the beneficiaries
  2. Decrease estate tax liabilities
  3. Ensure that the assets of the decedent are professionally managed

Since the testamentary trust does not become active until after the individual has passed away, the will must select a predetermined representative (an executor) to carry out the trust instructions. The decedent’s estate can only be transferred into the newly created trust after he or she has passed away.

In general, the testamentary trust can be created so that the decedent’s estate is only distributed to the beneficiaries if certain conditions have been met. For example, the decedent may have stated the money is for the son’s education only if entering a bona fide four-year college program, after which the remaining balance will be paid out. A testamentary trust can also be created to distribute the assets to a named charity or charities, according to the wishes of the decedent.

REQUIREMENTS FOR A TESTAMENTARY TRUST AND LIVING TRUST

To create a testamentary trust or a living trust, the following is required:

  1. A trustor or grantor who creates the trust
  2. The trustee who will manage the assets held in the trust
  3. Name of beneficiary or beneficiaries

ESSENTIALS OF A TESTAMENTARY TRUST

  1. A testamentary trust will contain a provision within the will that should outline the representative or executor and instruct that individual to create the trust. However, the trust is not effective immediately, but only after the death of the decedent because the will has to go through probate. At this stage, the executor first has to settle the estate with creditors, lien holders, and the IRS.
  2. A testamentary trust remains in effect until the trustor has named a specific time or date. For example, the creator may state that the funds should not be given to the daughter until she completes college, or until she reaches age 21.
  3. After probate is completed, the trust is established, and the executor has the legal right to transfer the estate into the trust. The trustee assigned to manage the trust will do so until the trust expires. At that time, the beneficiary will receive the remaining assets.
  4. In most cases, the trust expiration will be tied to a specific date or event, such as the beneficiary reaching a stated age, graduating from college, or getting married. Up until the expiration of the trust, it is not unusual for the probate court staff to check regularly to ensure that the trust is managed properly.
  5. The trustor is at liberty to select anyone as a trustee, but the latter is not obligated to accept the request. If the executor cannot find a trustee, the court will usually appoint a trustee. In some cases, a colleague, friend, or relative of the beneficiary may be asked to act as a trustee. Naturally, everyone should try to select a trustee they believe will be honest and have good moral principles.

TESTAMENTARY TRUST VS LIVING TRUST

In a testamentary trust vs. living trust, each may contain some or all the assets outlined in the will made by the decedent. However, a testamentary trust is only established after the death of the person and does not become active immediately. On the other hand, a living trust is created during the individual’s lifetime, whereby the trustee is responsible for managing the assets for the benefit of the beneficiary or beneficiaries of the trust.

While in a testamentary trust, the instructions can be written while the trust maker is still alive, the trust is not active until after the individual dies. It is only then that the assets can be distributed and placed in the trust. With a living trust, however, which is created while the trustor is alive, the assets can be distributed to the beneficiary at any time.

Further, a living trust may be revocable or irrevocable. With a revocable trust, the trustor is permitted to make any changes, but not so with the irrevocable trust. On the other hand, once a testamentary trust becomes active, it is always irrevocable since the trustor has passed away.

PROS AND CONS OF A TESTAMENTARY TRUST

Although a testamentary trust is an effective tool for estate planning, it is important to know the pros and cons of this particular trust.

Advantages

  1. A testamentary trust is useful if a parent has young children and wants the assets distributed to them in case he or she dies prematurely. The parent can write specific instructions such that the assets will be distributed when the beneficiaries reach a specific milestone. For example, the assets from the trust may only be distributed after the children turn age 18 (as one stipulation).
  2. Another positive about testamentary trusts is that they can be altered or modified while the grantor is still alive. At this point, the trust is not yet active and it is revocable and, therefore, it can be modified.
  3. There are scenarios where parents may not be well off or may not have the funds to create and maintain a living trust. In this case, the creation of a testamentary trust within the will is beneficial since it will only come into effect when the parent(s) have passed away, leaving possible benefits after their death.
  4. The cost to create a testamentary trust will be paid from the decedent’s estate; therefore, no cost will be attributed to the grantor. Later, if the grantor has funds, he or she can create a living trust and rescind the testamentary trust.
  5. A testamentary trust is relatively cheap to create and may be an option if there are limited funds.
  6. A testamentary trust is an ideal option for beneficiaries who require more accountability and oversight.

Disadvantages

  1. A key disadvantage of a testamentary trust is that it does not avoid probate. This means the personal representative must go to court, register the will, have it validated, and wait until probate is over (potentially several months) until the assets can be distributed to the beneficiary(ies).
  2. Since the testamentary trust goes through probate, it automatically becomes part of public records and there is no privacy.
  3. Sometimes the testamentary trust may not be created properly when the person was alive and thus the wishes of the decedent may not be properly executed.

ADVANTAGES OF A LIVING TRUST

  1. A living trust Is a great option for those wanting to avoid probate as the trust protects the assets from the courts and creditors.
  2. A living trust also protects your privacy since the document is kept out of public records.
  3. By avoiding probate, you have neither court nor legal fees, which can be substantial.
  4. If you feel that you may need to modify your trust in the future, then a revocable trust is a good option.

DISADVANTAGES OF A LIVING TRUST

1. Most people see the expense of setting up a living trust vs. testamentary trust as a drawback. However, expenses with probate remain, and often they can be fairly equal. Always speak with a trusted lawyer who has experience with wills and trusts before making a final decision.

2. A living trust does not offer any specific tax advantages because it can be revoked at any time. No benefits can be put toward tax planning as well.

3. A living trust can be complex to draft, leading to it being more expensive. However, if you are in need of a detailed effort, a living trust can still be beneficial to serve those goals.

KEY DIFFERENCES BETWEEN TESTAMENTARY TRUST VS. LIVING TRUST

  1. A living trust vs. testamentary trust comes into effect as soon as it is created, as long as the assets are available. On the other hand, a testamentary trust only comes into effect after the grantor has passed away.
  2. In general, a living trust bypasses probate, which can be a lengthy and expensive process. Testamentary trusts must go through probate, along with the will.

CONCLUSION

Choosing between a testamentary trust vs a living trust can be difficult. Setting up an estate plan can appear to be a tricky process because of the vast number of options. The key is to consult with an experienced estate lawyer who can guide you as to what the best option is for you. There is no single tool or trust that applies to every person. It all depends on your specific situation, personal preferences, financial goals, and the number of assets. What should you choose: a living trust vs testamentary trust? At Elder Law, P.A. we are an experienced group with great familiarity with all types of trusts and wills. Call us today at 1-561-933-4465 and speak with a knowledgeable attorney.

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