Testamentary trusts can be a useful tool in creating an estate plan, and ensuring that spouses who remarry, children from previous marriages and disabled children are all looked after. They are established through a will and become effective upon death.
A trust requires three people:
- The settlor is the creator of the trust, who transfers property to it. In a testamentary trust, the person making the will is the settlor, and his or her estate, or specific assets from the estate, are designated as the trust property;
- The trustee, on the other hand, holds legal title to the trust property. Typically in a testamentary trust, the executor/estate trustee of the will is appointed the trustee; and
- The beneficiary is the person(s) for whom the trust has been created, and who has a stake in the trust. Via the testamentary trust, the beneficiary receives part or all of his inheritance.
There are different types of testamentary trusts, each one offering different benefits. These include spousal trusts, trusts for beneficiaries with special needs, and trusts for minors.
It is entirely possible that a person could leave his entire estate to his spouse, with the understanding that she would share it with his children. But without a spousal trust in place, there’s no guarantee the spouse will follow through on that agreement, and there is no mechanism to enforce it.
Should the spouse remarry, and leave all her assets to a new spouse, the will maker’s children would likely receive nothing. The person making the will would, in effect, be giving away a significant portion of his estate to another person, without intending to do so at all. Also, if the will maker’s spouse failed to plan adequately, or spent all of the assets in the estate before they could be shared with his children, they would be disinherited.
With a spousal trust, the person drawing up the will can ensure his or her spouse is provided for by instructing the estate trustee to make payments to him or her from the trust income, with or without discretion to encroach on the capital. Upon death, the remaining capital would be distributed to the children and/or grandchildren.
In this way, the spousal trust ensures a current spouse is adequately cared for, while making provision for other beneficiaries.
A spousal trust is also a useful tool for providing for a spouse who is ill, incapacitated or not sophisticated enough to make financial decisions.
Trusts for a special-needs beneficiary
Testamentary trusts are also used in providing for a beneficiary with a mental and/or physical disability. In these cases, a good option is a Henson Trust.
With this type of trust, a trustee will assist and in some cases be entirely responsible for making financial decisions on behalf of the special-needs beneficiary.
Testamentary trusts that give a trustee absolute discretion in the distribution of funds can also help protect government benefits that a disabled beneficiary may be receiving.
Trusts for minors
Since minors cannot hold legal title to property, a testamentary trust is a must for a client who wants to leave an inheritance to minor children through his will. One of the benefits of using a testamentary trust is that the person making the will can decide at what age he or she would like the children to receive their inheritance.
For parents concerned about children receiving too much money too early, it is possible to structure the trust so that a child receives portions of his inheritance at different ages. For example, at age 18 the child might receive one-third of the inheritance, another one- third at age 21, and the remainder at age 25.
The trust can also be set up so that the trustee has the discretion to pay out money to the beneficiary in between each distribution, depending on the child’s needs.
Here’s a scenario
Ted and Susan are an affluent married couple in their fifties. Ted is a corporate executive and Susan owns a successful computer graphics business.
Both Ted and Susan have been married before. Ted has three adult children from his first marriage. Susan has one adult child from her previous marriage and she and Ted have one child, who is still a minor.
Ted’s total assets include several investment accounts, a home in Florida, and a cottage that has been in his family for several generations.
Ted has approached you to assist him with creating an estate plan. One of his concerns is regarding the inheritance he will leave his current wife and children.
Ted wants to know that his wife will be adequately provided for, while ensuring that his adult children and minor child will receive an inheritance as well.
Ted is also concerned that if he leaves his entire estate to his current wife, and she remarries, that person may have access to his estate, to the detriment of his children.
In addition, Ted wants to ensure the family cottage stays in the family, and that Susan does not sell it. He asks you for advice in creating an estate plan that will address these concerns. How will you approach it?
To address Ted’s concern about his children’s inheritance, Ted can have testamentary trusts created in his will.
He could first create a spousal trust, providing for Susan during her lifetime, whereby the trustee would have discretion to pay her income from the trust, with power to encroach on the capital.
In the testamentary trust, Ted could also indicate that upon Susan’s death his adult children are to receive the remainder of the assets in the estate.
He could further create a testamentary trust for his minor child, making provisions for his educational and other needs, and distributions of the inheritance at different stages of the child’s life.
Regarding the cottage, Ted can have the trust worded in a way that Susan would have use of the cottage during her life, and upon her death, the children would inherit it.
Testamentary trusts should be considered when a person wants to make provisions for spouses as a result of remarriage, adult children from prior marriages, minor children and disabled beneficiaries. They are a useful way of providing peace of mind to the will maker, knowing he has looked after everyone left behind.