When it comes to estate planning, trusts offer a more flexible way to manage your assets when you’re alive or after death. However, choosing the right type of trust that matches your needs and protects your wealth as you would wish can be challenging because there are many types of trusts, and each serves a distinct need.
Testamentary trusts and living trusts are just two of the many legal tools you might come across during estate planning. Understanding how they differ and their advantages or disadvantages is essential in making an informed choice.
What Is a Testamentary Trust?
A testamentary trust is a legal arrangement created for the distribution of wealth or assets that becomes effective after the trust creator’s (also known as grantor) death.
Process: First, the grantor creates a will and then includes the terms of the testamentary trust in it. Upon death, assets specifically designated in the will are retitled and used to create and fund the trust. The trustee then oversees the management and distribution of these assets to named beneficiaries as stipulated.
For Whom: Testamentary trusts are a perfect estate planning tool for those wanting control over the estate after death because they outline distribution provisions. They are also ideal for married couples with minor children or beneficiaries who cannot manage their inheritance for one reason or another.
Since they go into effect after death, testamentary trusts are irrevocable, meaning they cannot be updated, amended. The trustee manages distribution, but they cannot make any amendments, such as removing beneficiaries or retitling more assets into the trust. However, the grantor can update trust provisions included in the will when they’re alive.
What Is a Living Trust?
Also known as inter vivos trust, a living trust is created and goes into effect when the grantor is still alive and of sound mind.
Process: A grantor creates the trust and funds it during their lifetime by transferring assets and outlining how they will be distributed in case of death or incapacitation. Typically, a grantor will appoint themselves as the trustee when they are alive but also name a successor trustee to oversee asset distribution after death.
Keep in mind that the trust (the legal entity created) owns assets in a trust, and you, as the trustee, are just an overseer and decision-maker.
Revocable Trust vs. Irrevocable Trust
A living trust can be revocable or irrevocable depending on the grantor’s estate planning needs.
- Revocable living trusts can be edited, updated, or terminated during the grantor’s lifetime as long as they’re of sound mind.
- Irrevocable trusts, on the other hand, are set in stone, and only under very rare circumstances can the owner or a beneficiary change the terms. This arrangement can help avoid or reduce estate tax, but it also means appointing a third-party trustee, not you, as the grantor.
Living trusts offer special benefits for those wanting ongoing asset management and to avoid probate. When you create a revocable living trust, its terms automatically become irrevocable after death.
Key Differences Between Testamentary and Living Trusts
Testamentary trusts and living trusts are important estate planning tools that serve the distinct needs of estate owners. While one ensures proper distribution of wealth after a grantor’s death, the other allows the grantor to manage their wealth and make plans for the future while still alive.
Other key differences between testamentary and living trusts include:
| Attributes | Testamentary Trust | Living Trust |
|---|---|---|
| When the trust goes into effect | Established through the provisions stated in a will and goes into effect only after the grantor’s death. | Created when the grantor is alive and goes into effect immediately after it’s signed and funded. |
| Cost | It costs less to create because it’s part of a will. | Typically more expensive to establish and maintain because the setup process is complex. |
| Control of the trust | The grantor doesn’t have control over the assets during their lifetime since the trust is established after death. | Grantor can choose to have total control of the assets in a trust until death or incapacitation. |
| Flexibility to revoke | Trusts are automatically irrevocable because they go into effect after the trustee’s death. | Grantor can amend or revoke the trust as long as they’re alive, of sound mind, and the trust created is revocable. |
| In case of incapacitation | Beneficiaries receive their distribution only after the grantor’s death and not incapacitation. | Beneficiaries can begin to receive distributions after the grantor’s incapacitation and before they pass away. |
Pros and Cons of a Testamentary Trust
While a testamentary trust offers more control over the distribution of assets after death, it has several shortcomings that are essential to understand before settling on it for estate planning.
Advantages of a Testamentary Trust
- Protects beneficiaries who are minor children by holding and managing their inheritance until they’re of age or meet the conditions outlined in the trust.
- It’s ideal for estate owners wanting more court oversight on their asset distribution.
- Generally less expensive to establish and manage because it’s part of the will.
- May help reduce or avoid estate tax requirements when done right.
Disadvantages of a Testamentary Trust
- Testamentary trusts must go through the lengthy, and sometimes costly, probate process.
- Does not offer privacy because it’s part of a will, which is a public record.
- Beneficiaries cannot access trust assets during a grantor’s incapacitation and can only do so after death.
Pros and Cons of a Living Trust
Living trusts provide more flexibility and asset control during a grantor’s lifetime, but they can also be daunting to manage and maintain. Here are the advantages and disadvantages of creating a living trust so you can make an informed decision:
Advantages of a Living Trust
- It doesn’t go through probate, therefore avoiding legal complexities and delays in asset distribution.
- It offers more flexibility during the grantor’s lifetime because they can choose between a revocable or irrevocable living trust.
- Unlike a will, the living trust is a private record that protects your beneficiaries, especially in the case of large estates.
- Provides control of the trust’s assets even when the grantor is alive.
Disadvantages of a Living Trust
- The initial setup cost is often high because living trusts are more complex to establish than testamentary trusts.
- The ongoing management required can be daunting and time-consuming.
How to Choose the Right Trust for Your Estate Planning
Choosing the right trust for estate planning depends on your individual needs. It’s possible to create a trust without an attorney if you understand the differences in features, state-specific laws, and what’s required of you during the process.
Some factors to consider when deciding between the two types of trusts include:
- Family situation: Grantors who are married and have minor children or special needs persons as beneficiaries may benefit more from a testamentary trust because they allow customized provisions to safeguard their inheritance.
- Probate and privacy concerns: If one of your goals for establishing a trust is to avoid probate, a living trust will offer this, as well as the confidentiality of your estate’s details and heirs.
- Size of the estate: If you have a large estate, choosing a living trust may be the best option because of the privacy accorded, potential estate tax reduction, and probate avoidance.
- Plans for incapacitation: Estate owners wanting to make plans for the management of their affairs upon incapacitation will benefit more from a living trust because it allows them to make such arrangements.
- Cost and maintenance: The cost to create and manage a living trust tends to be higher than a testamentary trust because the latter is executed through the will. However, the cost of the probate process, which is compulsory for testamentary trusts, may overwhelm your beneficiaries, especially if there’s a contest to the will.
- Flexibility: A revocable living trust offers flexibility by allowing mentally competent grantors to amend or revoke the trust during their lifetime. However, it’s important to note that testamentary trust grantors can amend or update the terms through the will when alive as well.
- Grantor’s age: Young persons in good health and with a family may benefit more from the features of a testamentary trust that lays out plans for asset distribution to beneficiaries after death.
If you’re uncertain about any of these aspects of a living trust vs. testamentary trust or are having a hard time choosing the right one for you, consider seeking legal advice from an estate attorney for clarity.
