What it means
Cornell's Legal Information Institute defines a testamentary trust as a trust created in a will, which begins upon the death of the testator, the person who made the will. Until that death, there is no trust and nothing to manage.
The will itself names who will get what and who will run the trust. The contrast is with a trust made during life.
The Illinois State Bar Association describes a revocable living trust as one created and funded in life, which the creator can change or cancel, and an irrevocable trust as one that cannot be modified. A testamentary trust, in the same guide, is created and funded at death.
The IRS draws the same line for tax purposes. Its Form 1041 instructions say a trust may be created during a person's life (inter vivos) or at death under a will (testamentary).
A trust or a decedent's estate is treated as a separate legal entity for federal tax purposes. The ISBA lists reasons people use trusts, including providing for minor children, for a person with a disability, or for someone who cannot be trusted with a lump sum.
A testamentary trust can do those jobs and takes effect only at death. A person who does not want to fund a trust in life can leave the instructions in the will.
There is a trade-off. The ISBA lists avoiding probate as a reason to use a trust, which applies to trusts funded in life.
A testamentary trust is written into a will, so the will generally goes through probate first, which can mean more time and cost. A trustee runs it, because the will names a trustee and that person follows the will's terms, and for tax filing the IRS says the fiduciary should review a copy of the will or trust instrument before preparing the return.
The terms matter, since they set who gets income, who gets principal and when the trust ends. A typical goal is to hold a child's inheritance until an older age.
In practice
Real-world examples.
Example
A fictional parent's will leaves $300,000 to a trust for a 10-year-old child, to be paid out at ages 25, 30 and 35. The trust does not exist until the parent dies. The trustee named in the will then holds and invests the money.
Example
A fictional widow leaves her home and savings to a trust for her adult son, who has a disability. The will names a sibling as trustee. The trust pays for his needs and takes effect only after her death.
Example
A fictional couple compares two plans. Plan A is a revocable living trust funded now. Plan B is a testamentary trust in each will, with no setup cost during life, though the wills must go through probate.
Formula
Calculation
There is no formula. A simple split illustrates the payout idea: a $300,000 trust paid in equal thirds at three ages pays $300,000 / 3 = $100,000 at each age, before any growth or expenses.
Worked example. If the trust earns growth and the balance is $330,000 by the first payout age, and the will pays one third of the balance at that point, the first payout is $330,000 / 3 = $110,000. The remaining $220,000 stays invested for the later payouts, and each later payout is a larger or smaller share depending on what the trust earns and spends.Case study
Seen in the real world.
This case study is fictional and illustrative. Hana, a single parent, has a 7-year-old daughter and a modest estate of $400,000. She does not want to fund a trust now, so her will creates a testamentary trust for her daughter and names her brother as trustee. The will says the trustee may pay for education and health costs, and will pay the rest out in thirds at ages 25, 30 and 35. If the trust holds $360,000 at age 25 and nothing was spent from it, one third would be $120,000.
When Hana dies, the will goes through probate. After the court process, the trust is set up and the brother starts managing it. The trust files its own tax return as a separate entity. The lesson is that this tool protects a child's inheritance with no cost during life, but it starts after probate. Hana should review the plan with an estate lawyer as her situation changes.
Watch out
Common mistakes.
- Assuming a testamentary trust avoids probate, when it is written into a will and generally needs the will to be probated first.
- Thinking it exists while the person is alive, when it begins only at death.
- Forgetting the trust is a separate taxpayer, and that the fiduciary may have to file its own tax return.
Questions
People also ask.
What is a testamentary trust?
It is a trust created in a will that begins when the person who made the will dies. The will names the trustee and the terms.
How is it different from a living trust?
A living trust is created and funded during life. A testamentary trust is created by the will and takes effect only at death.
Does a testamentary trust avoid probate?
Generally no. Avoiding probate is a reason to use a trust funded in life. A testamentary trust comes from a will, which usually goes through probate first.
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