What Is a Testamentary Trust?

A testamentary trust is a legal arrangement that outlines how a person’s assets will be managed and distributed after they pass away. Established through a last will and testament, this trust provides a way for individuals to dictate specific conditions for when and how beneficiaries, such as children or other loved ones, will receive their inheritance. The process does require probate to administer the will and may involve ongoing court oversight. Still, a testamentary trust can serve as a useful option for those who want to ensure their assets are handled according to their wishes while offering financial structure for the future.

Considering which options are best for you? A financial advisor with estate planning expertise can help create a plan based on your family’s needs and goals.

What Is a Testamentary Trust?

Unlike a living trust, a testamentary trust comes into existence only after the settlor dies. The grantor can make changes up until their death, at which point the trust’s terms generally become irrevocable. The testamentary trust is created under the will and is typically funded during estate administration. The trust won’t transfer assets outside of probate since the grantor owns the assets at the time of death.

Like all trusts, a testamentary trust allows the creator to stipulate how the assets within the trust fund will be disbursed. People often use testamentary trusts if they want to be able to specify when they leave their assets to a beneficiary. For instance, a parent might not want to leave their assets to their child until they turn 18 or graduate from college. The trust would terminate when the beneficiary receives the specified assets.

There are two basic types of testamentary trusts: a family trust and a separate trust. In the former, also known as a pot trust, a family manages its assets together. They are able to disburse funds from the trust to beneficiaries as needed. Parents commonly use this type of testamentary trust to create a trust for a child with special needs.

A separate testamentary trust, meanwhile, is set up for each child separately. This way, each beneficiary can get equal portions of assets or money from the trust.

Who Does a Testamentary Trust Involve?

A testamentary trust involves three parties. The settlor or grantor creates the trust in order to transfer their assets, while the beneficiary is the person or entity that receives those assets. The trustee handles the trust and manages the assets until the beneficiary takes over.

For example, a settlor may have a 3-year-old daughter to whom they want to leave a certain amount of assets. The settlor could name their brother as the trustee. This means the brother would be responsible for managing the assets until the settlor’s daughter reaches the age of 18, or whichever milestone the settlor marked in the will. Once the settlor’s daughter, who is the beneficiary, turns 18, she will receive the assets. The trust would then terminate at that point.

Since a testamentary trust is formed within a will, the probate court is also an involved party. The probate court must first determine the authenticity of the will, after which point the trust is created.

The probate court is also there to ensure that the trustee is correctly handling the trust for its duration. Depending on state law and the terms of the trust, the trustee may have to submit periodic accountings or reports to the court.

How to Create a Testamentary Trust

A couple creating a testamentary trust with their financial advisor.

A person creates a testamentary trust as part of a last will and testament. To do so, the settlor first must select the trustee and the beneficiary and specify the assets they’d like to place in trust. The settlor also has the ability to specify when and how to disburse the trust to the beneficiary. The last will and testament should detail all of this information.

Upon the settlor’s death, the will goes through the probate process. During estate administration, the executor generally transfers the designated assets to the trustee after meeting the applicable requirements. The trustee can then manage and distribute those assets according to the will. Many testamentary trusts include provisions specifying when some or all of the beneficiaries receive their trust allocations (e.g., at age 18). If this is the case, the trustee may have ongoing reporting obligations.

Advantages and Disadvantages of Testamentary Trusts

The major benefit of a trust is that it gives the settlor control over the disbursement of their assets. This is especially important for settlors who have young children or grandchildren. With a testamentary trust, assets can remain protected until the child is old enough to be financially responsible.

Another advantage of a testamentary trust is that you can fund it with life insurance proceeds after death. To do this, the settlor must generally designate the trustee, in that capacity, as the beneficiary of the life insurance policy. They can do so using the insurer’s required beneficiary designation procedures. Once the settlor dies, the life insurance policy will pay out into the trust.

While a testamentary trust has low upfront costs, the fees from probate court can add up. The trustee may have ongoing accounting, reporting or court-related obligations, depending on state law and the circumstances of the trust. If the trust endures for many years, the court fees and administrative expenses can eat up a significant chunk of money.

Creating a trust after death can also cause its own problems. The trustee may be unsure of how to interpret the provisions and can no longer ask the settlor for clarification. It’s even possible the trustee might not want the responsibility. For someone who wants to create a trust and have control over asset disbursement, it may be in their best interest to create a revocable trust while alive. With a revocable trust, it’s easier to have discussions and make any necessary changes.

Bottom Line

A woman reviewing whether a testamentary trust is right for her with her financial advisor.

Many may think trusts are best for the wealthy, but they actually hold value for many different kinds of people. In turn, you may want to speak with a financial advisor or estate planning attorney about how a trust could be worked into your plans. A testamentary trust is one option that could be helpful, though there are many other types of trusts you could take advantage of instead. Of course, you should also have a will laid out for anything not included in your trust.

Tips for Estate Planning

While you can do it yourself, there are numerous pitfalls to DIY estate planning. You may want to work with a financial advisor for complex estate planning needs. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Once you decide on your beneficiaries, don’t forget to update your retirement accounts, pensions, life insurance and brokerage accounts. Aside from choosing your beneficiaries, you’ll also need to designate power of attorney. If you have minor children, you’ll need to determine a guardianship plan.
It’s important to take steps to minimize estate taxes. Otherwise, your beneficiaries could lose a significant chunk of their inheritance to taxes. Some strategies to consider include giving portions of your assets to family members through gifts or setting up an irrevocable life insurance trust.