Testamentary Trust: How It Works, Pros and Cons

A testamentary trust is a type of trust created by the terms of your will. Unlike other trusts, it's only funded upon your death. It can help you control the distribution of your assets to your children and other beneficiaries after your death.

You can include multiple testamentary trusts in your will, including for charitable donations. This setup can help you combine the advantages of both wills and trusts by ensuring your assets are distributed according to your wishes.

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How a testamentary trust works

It's best to work with a financial advisor and/or an estate planning lawyer to ensure your financial goals are met and that your testamentary trust complies with your state laws and can pass through probate as smoothly as possible. In basic terms, you'll first need to do the following:

• Write a will. All of the information for a testamentary trust is contained in your will. This includes naming the trustee and the beneficiaries and detailing which assets go in the trust. You may also want to include distribution instructions, including how the assets should be allocated over time and when the trust should expire.

• Name a trustee or executor. The activation of a testamentary trust happens after your death. At this point, your trustee or will executor is responsible for the probate process and the distribution of your assets once it's complete. If minor children are involved, the trustee must return to probate court every year to verify that the assets are still being distributed correctly.

Testamentary trusts typically can include any assets and operate under any timeline of your choosing^[0]

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Pros and cons of a testamentary trust

Advantages of a testamentary trust

A testamentary trust is less costly upfront than other trusts because it's not activated until after your death. Also, you can change the terms of the testamentary trust. Like other trusts, it can be a helpful estate planning tool if you have minor children who can't directly receive your assets until they come of age. Certain types of trusts may also help reduce estate tax liabilities.

Disadvantages of a testamentary trust

A testamentary trust may be more complicated for your beneficiaries. Because there’s a will involved, they must go through the probate process to verify that will before it can take effect, which can delay the distribution of your assets^[0]

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Taxation and testamentary trusts

Since a testamentary trust is its own financial entity, the IRS considers it a separate taxpayer and it needs to file its own tax return^[0]

However, like other trusts, testamentary trusts can't be taxed twice, meaning your beneficiaries may not have to pay taxes on principal they receive from the trust (they may have to pay taxes on interest income they receive from the trust).

Testamentary trust vs. living trust

The main difference between a testamentary trust and a living trust is that a living trust takes effect during your lifetime and a testamentary trust takes effect when you die. Living trusts can be either revocable or irrevocable; revocable trusts can be changed at any time, but irrevocable trusts can help avoid estate taxes. A testamentary trust is irrevocable and can’t be changed once it comes into effect^[0]