My office frequently interacts with compliance officers of major banks and brokerage firms. From time to time, we receive curious inquiries from their offices after a client dies. This is because the deceased client’s trust may subdivide into one or more “testamentary trusts” that continue on to benefit the client’s spouse, children or other beneficiaries. The brokerage office will ask me for a copy of the trust for the spouse, children or other beneficiaries – when they already have it! You see, the testamentary trust was built inside of the revocable trust that they already possess.
If compliance officers inside of major banks and brokerage offices don’t understand what a testamentary trust is, I thought that this might be a good topic for today’s column.
What is a Testamentary Trust
A testamentary trust (sometimes referred to as a trust under will) is a trust which arises upon the death of the testator, and which is specified in his or her will or revocable living trust. A will or revocable living trust may contain more than one testamentary trust and may address all or any portion of the estate.
There are four parties involved in a testamentary trust: (1) the person (referred to as the “grantor” or “settlor“) who specifies that the trust be created, usually as a part of his or her will or revocable living trust – from which the testamentary trust “springs into being” upon the settlor’s death; (2) the trustee, whose duty is to carry out the terms of the testamentary trust; (3) the beneficiary(s), who will receive the benefits of the testamentary trust; and possibly (4) The probate court where the testamentary trust is created by a will as opposed to when a testamentary trust automatically is created under the terms of an inter vivos (commonly referred to as a “revocable living”) trust.
A “marital trust” that benefits a surviving spouse inside of someone’s will is a testamentary trust, as is a “credit shelter” trust which may be used to consume the decedent’s federal estate tax exemption. A continuing trust for a child or grandchild for educational, health or general needs is another example of a testamentary trust. So is a charitable remainder trust that springs out a revocable trust or will as of the settlor’s death.
So, you can readily determine now that a testamentary trust is one that doesn’t come into being until the settlor’s death and is usually found inside of an existing document such as a revocable living trust or a last will and testament.
When the compliance office of the bank or brokerage house asks for a copy of the testamentary trust instrument, I can usually tell them that they already have it. They just need to look inside of the revocable living trust to one of the Articles. An Article that is entitled “Marital Trust,” for example, is a testamentary trust. Same for a “Family Trust” or “Educational Trust” found within the pages of the original instrument.
Trustees and Testamentary Trusts
The trustee of the testamentary trust may be a different party than the one who serves as the trustee of a revocable living trust. Typically, the settlor of a revocable living trust serves as his or her own trustee during the course of his or her lifetime. Upon the settlor’s death, however, that person can obviously no longer serve as their own trustee. When the trust therefore divides into the testamentary trust shares, another person, bank or trust company serves.
There may even be a different trustee for each different testamentary trust formed. The spouse, for example, might be named as the trustee of the marital trust. An adult child who is the beneficiary of a continuing general needs trust, formed for his or her own benefit, may serve as the trustee of his or her own trust share.
Testamentary trusts are usually irrevocable, meaning that the terms cannot be changed or altered. This is because the settlor who created the trust has died. Even if the settlor reserved the power to amend the trust, since he or she is now dead, the trust becomes irrevocable. The exception to this is when the testamentary trust grants a “power of appointment” to a beneficiary to change the terms of the trust. I’ve written about powers of appointment in other columns.
Testamentary trusts all have different estate and income tax ramifications. Particularly with the higher federal estate tax exemptions, it’s often better to review whether a marital trust is now more appropriate than a credit shelter or a family trust. Since many estates aren’t taxable under the federal law, we can minimize taxes for your children and other beneficiaries by planning to eliminate the capital gains through a step-up in tax cost basis. Credit shelter trusts and family trusts do not receive another step up at the surviving spouse’s death.
After reading this I hope that you are better informed as to what a testamentary trust is. If so, I offer you my hearty congratulations! You’re ahead of several compliance officers at major banks and brokerage houses that I’ve dealt with in the past few months!
©2022 Craig R. Hersch. Learn more at www.floridaestateplanning.com