What is a Testamentary Trust and Why Should I Consider One?

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Not only does death impose an emotional toll on family and friends, it brings with it a number of practical considerations.

Will your loved ones be able to move on without significant financial complications? Or will they be left with nothing after creditors claim what’s theirs? What about taxes? To a significant extent the answer to these questions hinges on whether you create a testamentary trust.

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What is a testamentary trust?

Explained in the most basic terms possible, a testamentary trust is an estate planning tool or legal mechanism provided in a will that has two significant advantages. First, it permits more control over the distribution of assets to beneficiaries. Secondly, it carries certain tax benefits.

Within this context, it is important to note that there are two types of testamentary trusts. The first is a discretionary testamentary trust. In this arrangement, the executor lets the beneficiary choose whether he or she wants to take a portion of their inheritance or their entire  inheritance via testamentary trust. As the primary beneficiary in this case, you are also authorised to remove and appoint the trustee, and appoint yourself  to administer your inheritance inside the trust.

Then there’s a protective testamentary trust. As a beneficiary in this case, you have no choice about how to take your inheritance, and you can’t appoint or remove trustees. Therefore, this type of testamentary trust is most often used in situations where the beneficiary is generally incapable of exercising fiscal responsibility, or is unable to manage the inheritance because of their age or disability.

But isn’t this the same as a family trust?

No. A family trust, which is legally known as an inter vivos trust, is generally designed to take effect while you are still alive. A testamentary trust doesn’t take effect until you die.

Some other key differences are:

  • The terms of an inter vivos trust are set out in a lengthy legal document called a trust deed.
  • The terms of a testamentary trust are stipulated in your will.
  • In general the terms of an inter vivos trust are much more comprehensive than those in a testamentary trust.

Selection of the trustee(s)

As we have already noted, a primary beneficiary of a testamentary trust can appoint a trustee. Here are a few things to keep in mind when doing so:

  • The trustee must be at least 18;
  • in most cases, the executor of the will is also the trustee;
  • it is important to choose someone you know and trust;
  • whomever you choose effectively control any assets within the testamentary trust;
  • choosing a neutral third party rather than yourself or a family member may afford more protection to the beneficiaries;
  • adult children usually serve as trustees when the testamentary trusts have been created for them;
  • appointing more than one trustee provides some protection for your children in a matrimonial property settlement, even though each child may be authorised to appoint themselves as the only trustee of their own trust.

What about the beneficiaries?

A testamentary trust may be a good option for you if you are concerned about protecting your husband or wife and/or your (infant or adult) children.

If you are creating one in order to protect a surviving spouse, the main beneficiary will be your husband, wife or the kids (depending on whether you want to preserve the assets  for the children) and your blood descendants.

If you are creating one to protect your adult children, the beneficiaries are usually those children, their kids, and their grandchildren.

Key benefits of testamentary trusts

By including a testamentary trust in your will, you can make it more difficult for creditors and disgruntled exes to claim assets meant for your beneficiaries.

Consider the following situation. You want to leave a considerable amount to your son. However, you also know that your son is deep in debt. If you just left the money to him in a ‘simple will’, his creditors could claim it fairly easily. On the other hand, if you put the money into a testamentary trust, the creditors couldn’t do so because legally, the money would belong to the trust, not to your son.

Now consider this scenario. You want to leave a significant amount to your daughter. However, you are also aware that she and her spouse have recently separated with no chance of reconciliation. Creating a testamentary trust rather than leaving the money to her in a traditional will will make it more difficult for her ex to claim the assets as long as she is not the only trustee.

The tax advantages of testamentary trusts

By now, you may be wondering about the tax advantages associated with testamentary trusts. These arrangements allow trustees to distribute and split the income and capital gains from the trust so that it minimises tax on the beneficiaries.

Specifically, distributions from a Testamentary Trust to children under 18 qualify for the full income tax-free threshold, with income greater than that being taxed at normal  adult rates. This means approximately $18,000 can be distributed to each child beneficiary tax free each year.

Additional considerations

In summary, a testamentary trusts offers significant benefits. However, that doesn’t necessarily mean it is the best option for you. Here are some questions you should ask yourself to determine whether a testamentary trust is right for you and your estate:

  • Do you currently hold or is your estate is likely to hold significant assets?
  • Will your estate generate enough income to warrant a testamentary trust?
  • Are there any circumstances or conditions affecting one or more beneficiaries that impede their ability to manage money properly?
  • Would creditors or former spouses have legitimate claims to assets left to a beneficiary in a traditional will?

Clearly these are just some of the questions that must be answered before you commit to creating a testamentary trust. To learn more about this issue or how we can help with creation of a testamentary trust, contact us today.

At Big Law we provide holistic legal solutions to legal matters.

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