Testamentary Trust

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A testamentary trust is a trust that is specified in a person’s will, and that is handled upon that person’s death. A will can contain more than one testamentary trust. Testamentary trusts are different from inter vivos (“living”) trusts, which are trusts that are created and handled while the creator is still alive. To explore this concept, consider the following testamentary trust definition.

Definition of Testamentary Trust

Noun

  1. A trust that is detailed in a person’s will and distributed at some point after that person’s death.

Origin of Testamentary

1425-1475       Late Middle English

What is a Testamentary Trust

A testamentary trust is a trust that is specified in a person’s will, but is not formed until his death.  More than one testamentary trust can be detailed in a will. A testamentary trust is created to address a person’s estate that either was accumulated during his lifetime, or that resulted from a postmortem lawsuit or the settlement of a life insurance policy.

The trustee is in charge of the trust until the date that the trust expires, such as when the minor beneficiaries to the trust reach the age specified in the trust. Another example of a testamentary trust becoming active is by way of a beneficiary completing a set deed that would entitle him to the trust. These deeds could include educational goals or even the act of getting married.

Parties in a Testamentary Trust

There are four parties in a testamentary trust:

  • The Settlor – The settlor is the person who creates the trust, usually as part of his will. Some trusts are created in abeyance during a person’s lifetime, which means they are suspended until the terms of the trust are met. A settlor may also be called a “grantor” or “trustor.”
  • The Trustee – The trustee is responsible for carrying out the terms of the will.
  • The Beneficiary – The beneficiary is the person or persons designated to receive the benefits of the trust.
  • The Probate Court – The probate court is not a party to the trust itself, but it is still an essential part of the process. The probate court oversees the trustee’s handling of the trust to ensure that the wishes of the person who created the trust are properly followed.

Difference Between Testamentary Trust and Living Trust

The difference between a testamentary trust and a living trust is that a living trust goes into effect when the settlor signs the trust, has it notarized, and then transfer property into that trust. This kind of trust is called a “living” trust because it goes into effect while the settlor is still alive. Living trusts can be made to be either revocable or irrevocable. The term “testamentary” is the major difference between a testamentary trust and a living trust, because the very term means that the trust becomes active upon the settlor’s death.

An example of a testamentary trust that is a revocable trust is a trust that can be revoked at any time. The most common type of revocable trust is a living trust that is created with the intention of avoiding probate. Probate is the court-involved process of settling a person’s estate. It can be costly, time-consuming, and is often more trouble than it is worth. Property that is left to beneficiaries through a living trust can pass on to them without the need for probate.

Irrevocable trusts cannot be revoked once they’re finalized. This type of trust is typically used to transfer the ownership of property so as to reduce one’s taxes. There are several different versions of this type of trust. A few of them are detailed below:

  • Bypass Trusts – This is a trust that is used by spouses to reduce their estate taxes when the other spouse passes away. When the first spouse dies, his property goes into the trust. The surviving spouse can then use the property, but never outright owns it.
  • QTIP Trusts – These trusts are used by married couples to postpone the payment of taxes on the estate until the death of the second spouse. QDOT trusts are similar, though the difference here is that one of the spouses is a noncitizen.
  • Charitable Trusts – These are trusts that are created to reduce the settlor’s income and estate taxes via gifts he makes to charity.

A testamentary trust becomes irrevocable upon the death of the settlor. However, because a testamentary trust never becomes active during the settlor’s lifetime, he is free to make changes to it up until he passes away. This is another significant difference between a testamentary trust and a living trust.

Child’s Trust

The most common use of a testamentary trust is for children. A child’s trust is a trust that is set up so that money can be left to children through a will. The reason why a child’s trust is created in the first place is because minors, by law, are not allowed to receive substantial sums of money directly. Any money or property that is left to a child must be managed by an adult.

Not only does a child’s trust allow a settlor to leave money to a child, but it also permits him to name someone he trusts as the guardian of his gift. The trustee is then left in charge of the trust until the minor becomes of age and can effectively manage the trust himself. The minor is not automatically granted the trust just because he reaches the legal age of 18 or 21. The settlor decides the age at which the minor will receive the trust and specifies that age in his will.

For example:

Tom and Barbara have one child together, Stephanie. When Tom and Barbara make their will, they leave everything to each other. They also name Stephanie as an alternate in case they both die at the same time. However, Stephanie is a minor, so they must figure out who will manage her property until she is old enough to be able to do it herself.

They decide to create a child’s trust in their will, naming Barbara’s brother as the trustee, and specifying that Stephanie cannot touch the trust until she is 18 years old. Now, if Tom and Barbara die at the same time, their property will go into the child’s trust, and it will be managed for Stephanie’s benefit by Barbara’s brother, until Stephanie turns 18, at which time she can claim it herself.

There is also a type of trust known as a “pot” trust. A pot trust is incorporated into a will when there are multiple children to include in the will. This works to distribute the property evenly to the children in accordance with the wishes of the settlor(s).

Testamentary Trust Example Involving a Reformed Trust

An example of a testamentary trust being brought before the courts occurred in 2002. John P. Harris died on April 13, 1969, and his will was admitted to the probate court. Included in his will was the John P. Harris Testamentary Trust. This trust appointed three entities as trustees: his son, John G. Harris, The First National Bank of Hutchinson, and Peter MacDonald.

Income from the property in the trust was to be paid to Harris’ wife Rosalie, and his son, in equivalent shares. In the event that Rosalie died, her share of the income from the trust would go to John G. Harris, Kathy Sue, and Carol Lynn, Kathy and Carol being John and Rosalie’s other two children. Should those three die, then the income would go to their survivors, and their survivors’ survivors.

However, if John G. Harris were to die, then his share of the income from the trust was to be paid to his children, and then their survivors. The date of termination of the trust was 20 years and nine months from the death of Kathy Sue’s or Carol Lynn’s survivors, or of the survivors of John G. Harris’ other children. Upon the trust’s termination, the remainder was to be paid to Kansas Philanthropies, Inc.

On May 23, 2002, the John G. Harris and The First National Bank filed a petition asking the court to reform the trust. Peter MacDonald did not join in the petition, so he was assumed to either be deceased or, for some reason, no longer a beneficiary of the trust. The trustees asked that three revisions be made:

  1. They requested a change in their powers of discretion over the remainder of the trust, citing a mistake in the initial drafting.
  2. They requested the language of the trust be changed so as to protect the remainder of the trust from the beneficiaries’ creditors.
  3. They asked the district court to authorize them to divide the trust into three separate shares so the trust could be changed to a Qualified Subchapter S Trust (QSST), citing the failure to include such a clause as a mistake.

No one opposed these changes, and so the district court granted them. Unhappy, however, with the way the QSST was to be set up, the trustees filed an appeal. The Court of Appeals held that the district court’s modification of the trust that divided it into three separate shares did not have any negative effects for the beneficiaries, nor did it interfere with the original intentions of the trust. The Court of Appeals therefore affirmed the district court’s actions.

Related Legal Terms and Issues

  • Qualified Subchapter S Trust – A trust created around a small business wherein the shareholders pay the income tax on the trust, not the corporation.
  • Shareholder – Someone who owns shares in a company. A shareholder, also referred to as a “stockholder,” profits when the company makes money, but also loses money when the company is unsuccessful.