Eye on testamentary trusts: 7 benefits for clients

Clients who don’t have inordinately sizable estates may be seeking a simple trust option to protect the assets they do have. These people may be early in their careers and still have young children, for whom a trust can be the best vehicle to inherit wealth. Those factors can make a testamentary trust, one set up in the decedent’s will, a useful choice.

A testamentary trust technically doesn’t come into existence until the client’s death. Individuals commonly fund the trust from retirement plan assets (such as from a 401(k) or IRA) upon their death.

To do this, the client can name the trust as the beneficiary of the retirement plan. Life insurance proceeds can similarly be used to fund such a trust.

The biggest drawback of a testamentary trust: It requires the decedent’s will to pass through probate. Probate can be an unpleasant experience, and carries such a bad reputation, that the necessity of it may scare clients away from this strategy.

But for some clients, especially those for whom probate is still a long way off, the benefits may outweigh that drawback. Those benefits include:

• The client can change a testamentary trust at any time. Testamentary trusts don’t technically exist until after the trustor has passed away. As long as the client is alive, these trusts may be changed however the client chooses, or even revoked. At the time of the client’s death, assets that have been earmarked for these trusts are transferred to them, and the trust becomes irrevocable.

• The tax benefits for assets earmarked for minors kick in at a low level. With a testamentary trust, minors who receive the assets can take up to $10,000 per year without paying taxes on it. Anything more than this amount will be taxed at the regular income tax rates. Compared to a family trust, where minors start paying taxes at levels not far above $1,000, the tax advantage of a testamentary trust can be significant.

• The costs to the trustor are generally low. These trusts are simple to set up, generally not incurring expenses beyond the cost of preparing the will that establishes the trust. However, probate can be an expensive process.

• The trust can take care of especially needy beneficiaries, such as minor children or handicapped individuals. Those people can be named as the beneficiaries of the trust, with an older, more responsible person serving as their trustee. One caveat: The trustee is not necessarily obligated to honor the terms set out for expenditures in the will; and obviously, the trustor won’t be around to check up on this. That’s why it’s critical for the client to choose someone trustworthy.

• The trust can help protect assets from creditors. Since they’re commonly funded with retirement plans or life insurance, the assets aren’t in play until after the trustor passes away and the trust comes into effect. There’s no avenue for creditors or other wealth-seekers to take advantage of minor children and gain control of their assets.

• The trust can last as long as the trustor indicates in his or her will. And the dates of the trust do not have to be set in advance, which is key since the client won’t know when the trust goes into effect. It can be set to expire when the beneficiary graduates from college, for example, or turns a certain age.

• For estate planners, the simplicity of testamentary trusts makes them ideal for younger clients. They don’t require significant assets up front, only the expectation that, over a lifetime, the client will build up an estate. And remember, the trusts can always be revoked if the client so chooses. Testamentary trusts are thus an excellent vehicle with which to acquire estate planning clients — before they discover that they need estate planning.

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