What is a testamentary trust? How it works & when to use one

The assets you’ve worked hard to build can do more than simply transfer to the next generation. They can provide stability, guidance and long-term support for the people and causes you care about most.

A testamentary trust is one way to help ensure that happens—allowing you to outline how your assets should be managed and distributed after your passing. Here’s how it works and when it may make sense to include one in your estate plan.

A testamentary trust is created through your will and only takes effect after your death. After the court begins the probate process, the executor handles your estate and arranges for the assets to be transferred into the trust. Once the trust is funded, the trustee takes over, managing and distributing the assets according to the terms you outlined in your will.

Common reasons to include a testamentary trust in your estate plan include:

• Providing for the financial care of minors until they are old enough to own and manage the assets themselves. 
• Managing assets while controlling distributions over time. This is especially important if you have concerns about leaving heirs a large inheritance all at once.
• Protecting assets from creditors and preserving family wealth. In many cases, assets held in a properly structured trust may receive some protection from beneficiary creditors, depending on state law and the terms of the trust.
  

Since trusts and wills work differently, having both in your estate plan can allow you to structure your inheritance exactly as you choose, providing long-term oversight.

Now that you know what a testamentary trust is and why someone might use one, it can help to understand how the process actually works from start to finish.

A testamentary trust is established through your will, but it doesn’t become active until after your death. The process typically begins when the court oversees probate. During this time, the executor settles your estate and transfers assets into the trust according to your instructions.

Once the trust is funded, the trustee steps in. The trustee manages and invests the trust assets, keeps records and makes distributions to beneficiaries based on the terms you set. Because the trustee has a fiduciary duty, they are required to act in the best interest of the trust and its beneficiaries. Until assets are distributed, beneficiaries generally do not control the trust property.

Suppose Angela has two children, ages 10 and 12, and wants to make sure they’re provided for if she passes away before they’re grown. She decides to create a testamentary trust funded with an investment account worth $500,000. In her will, Angela can specify how the account should be invested and require the trust to distribute a set amount each year—such as $30,000 per child—to cover their living expenses.

The trust terms might also state that once a child reaches a certain age (for example, 21), or completes a milestone such as graduating from college, half of that child’s remaining share of the trust will be distributed to them.

Testamentary trusts become irrevocable when they come into existence upon your death. This means they generally cannot be amended or revoked at that point unless specific legal steps are taken. However, because a testamentary trust is created through your will—and your will can be updated during your lifetime—you can change the trust terms at any time before you pass away.

This structure allows your trust language to adapt as your circumstances or wishes change. Then, once the trust becomes irrevocable after your death, it provides your beneficiaries with certainty about how the assets will be managed and distributed.

It’s also important to understand how this affects taxes. Because the trust doesn’t legally exist until your death, any income earned by the assets is taxed to you during your lifetime. After probate, when the assets are transferred into the trust, the trust becomes its own taxable entity.

Testamentary trusts are created by a will when the grantor dies, while living trusts (as the name implies) are created and become effective while the grantor is still alive. This means they hold assets and begin functioning right away. 

Both living and testamentary trusts are valuable estate planning tools, but their differences make each better suited for specific goals, such as avoiding probate or structuring long-term distributions.

A testamentary trust can be helpful for people who want to structure how and when assets are distributed to beneficiaries. It may make sense to consider one if:

• Your beneficiaries are minors or not yet ready to manage assets on their own. A testamentary trust can help ensure your assets are managed responsibly and used to support their needs, such as housing, food, education and other key expenses.
  
• You want to guide distributions over time rather than leaving a large inheritance all at once. This can help prevent beneficiaries from feeling overwhelmed, encourage certain milestones or provide long-term financial support.
  
• You want to incorporate charitable giving into your legacy plan. Some people choose to structure charitable gifts through trusts such as charitable lead trusts or charitable remainder trusts, which can be designed to support loved ones and charitable causes.

Because trusts involve legal and tax considerations, an estate planning attorney can help you determine whether a testamentary trust aligns with your goals for wealth transfer, taxes and family legacy.

Testamentary trusts allow you to provide for a structured distribution of your assets after your death. This can ensure your loved ones receive the care they need and can be a key component of your estate plan. However, their irrevocability means they offer less flexibility, so it’s important that you pay careful attention to how you structure them.

Fortunately, you don’t have to figure it out by yourself. A Thrivent financial advisor can help you define your goals and decide if a testamentary trust is right for you.  You can also get started by exploring our Trust Services.