Advantages and Disadvantages of Creating a Testamentary Trust

A testamentary trust is a special kind of trust that is made through a person's will, as opposed to a living trust which is created during the person's lifetime. In a testamentary trust, it is only when the testator dies and the will is admitted to probate that the trust becomes effective. In contrast, a living trust becomes effective while the grantor is still alive.

Testamentary trusts have some good points, but there are also downsides. It can protect assets and give the testator control over what happens to their things after they die. It does not require an immediate distribution of the testator's assets, unlike in a last will and testament. However, testamentary trusts do not avoid probate. They can make beneficiaries wait longer to get their assets. Since the will becomes public record when the testator dies, the trust isn't very private. And if the will is not admitted to probate, the testamentary trust does not become effective.

Advantages of Creating a Testamentary Trust

There are several advantages in creating a testamentary trust.

Asset protection and control

Testamentary trusts can shield assets from beneficiaries' creditors because the trust, not the beneficiaries, owns the assets. The beneficiary owns only whatever is distributed to them or whatever they are entitled to receive, in accordance with the trust terms. The trust can include rules to protect assets from beneficiaries' potential financial mistakes or in cases of divorce. For example, a testamentary trust can be created only to pay for a beneficiary's education, with the trustee controlling the money and paying out funds as needed for tuition, books, and living costs.

Tax benefits

Setting up testamentary trusts in certain ways can help reduce estate taxes. Two good options are generation-skipping trusts and charitable trusts. Generation-skipping trusts stop the same money from being taxed more than once. With charitable trusts, the assets moved into the trust can be subtracted from the total estate value, making the taxable amount smaller. Also, when assets go into a testamentary trust, the beneficiaries get a "step-up in basis" to the asset's market value when the person who made the trust dies. So if the trust sells the assets later, capital gains tax is only paid on the increase in value from the stepped-up basis to the sale price. This helps save money on capital gains taxes compared to using the original purchase price.

Flexibility in distribution of assets

Testamentary trusts give the testator more control over how and when assets are given out, which is different from a will. With a will, assets are given to the beneficiaries right away. The trust can be made to fit the specific needs of each beneficiary. For example, it can pay for a child's education or support a spouse for their whole life. The trust can give out assets when certain things happen, like when someone reaches a certain age or achieves a specific goal. The trustee can choose how to give out assets based on how the beneficiaries' needs and situations change. For instance, a testamentary trust can be made to give a beneficiary a monthly income for as long as they live. When that beneficiary dies, the rest of the trust assets can be given to other beneficiaries.

Disadvantages of Creating a Testamentary Trust

There are also some disadvantages in creating a testamentary trust.

Does Not Avoid Probate

Testamentary trusts can't skip probate since they're made in a person's will. The will has to go through probate before the trust can start. Probate is when the court legally proves the will is real and handles the deceased's assets. The will must be sent to probate first before the person's assets can be moved to the trust. Probate can take a long time and cost a lot, with fees for the court, lawyers, and executor.

For example, when someone makes a testamentary trust in their will to hold a house for their kids, the executor has to file the will with the court, notify the heirs and beneficiaries about the will, and get the court's approval to probate the will before the house can be moved to the trust. This can be long and pricey, especially if the beneficiaries or creditors fight about it.

On the other hand, a living trust is made while the person is alive. It can avoid probate because the assets are put in the trust before the person dies. The trustee can then give the assets to the beneficiaries based on what the trust says, without court interference. But living trusts have their own pros and cons, like the cost to set up and fund the trust. This should be thought about carefully when choosing between a testamentary trust and a living trust.

Potential delays in asset distribution

It can take a while to transfer assets from the testator's estate to the testamentary trust. This is especially true if the will is challenged or the estate is complex. If someone contests the will, it can't be admitted to probate right away. That means the testamentary trust can't start yet. As a result, beneficiaries may face delays in receiving funds from the trust.

Lack of privacy

When someone dies, their will becomes public. If they made a testamentary trust in their will, everyone can see it. People can find out who gets money from the trust and what kinds of things are in it. This means the people getting money might get unwanted attention. Others might try to take advantage of them or get their money. Sometimes, it can also cause fights in the family that everyone knows about.

Factors to Consider When Deciding Between a Testamentary Trust and a Revocable Living Trust

When choosing between a testamentary trust and a revocable living trust, there are some important things to think about. One big thing is when the trust starts. A testamentary trust only starts after the person who made it dies and their will goes to probate. This means the trust's assets have to go through probate, which can take a long time and cost a lot. But a revocable living trust is made while the person is still alive. They put their assets in the trust before they die. This way, the trust doesn't have to go through probate at all because the assets are already in the trust when the person dies.

Another important thing to consider is how much control and flexibility each type of trust gives. With a testamentary trust, the person who made it can't really change it once the will is done. They would have to formally change the will itself to change the trust. But with a revocable living trust, the person keeps full control over the trust's assets while they're alive. They can add or take away assets, change who gets them, or even cancel the whole trust if they want to.

Privacy is also a key factor when deciding between a testamentary trust and a revocable living trust. A testamentary trust is made through the person's will, which becomes public when they die. This means anyone can see the details of the trust, like who gets what and what kind of assets are in it, by looking at the probate court records. But a revocable living trust is private. It doesn't become part of the public record. The trust agreement and its terms stay secret, giving more privacy to the person who made it and the people who get the assets.

The complexity and cost of setting up and keeping each type of trust should also be considered. Testamentary trusts are usually simpler and cheaper to make because they're part of the person's will. There aren't any extra costs or legal requirements besides those for making a valid will. But the probate process itself can be expensive and time-consuming, which might cancel out any initial savings. Revocable living trusts, on the other hand, need more work and money upfront to set up. The person has to work with a lawyer to write the trust agreement, transfer assets into the trust, and make sure the trust is funded properly.

Creating a testamentary trust is a significant decision that should not be taken lightly. The potential benefits of a trust, such as asset protection, tax savings, and flexibility in distribution, must be carefully balanced against the drawbacks, including complexity, cost, and potential delays. The specific circumstances of the testator, beneficiaries, and estate assets should be thoroughly evaluated to determine if a testamentary trust is the most appropriate solution. Should you need help in planning your estate or deciding which trust is appropriate for your requirements, contact the Law Offices of Albert Goodwin to discuss your specific legal needs to ensure that you are making the best choice for your situation. You can call us at 212-233-1233 or send us an email at [[email protected]. We are located in Midtown Manhattan in New York, NY.