A testamentary trust is one you create while you’re alive to be funded with assets in your probate estate at your death, according to the terms specified in your
will.
The trustee manages the property according to your wishes and makes distributions to designated beneficiaries based on the trust provisions.
A testamentary trust gives you continuing control over how and when your estate is distributed. For example, since you don’t know how old your children or grandchildren will be when you die, a testamentary trust allows you to postpone distributions until an age — say 25 or 30 — at which you believe they will be ready to manage their own inheritance. Or you might specify that the trustee has the discretion to provide money for specific uses in response to
beneficiary
requests.
Bypass trusts
One of the most common types of testamentary trusts is known as a bypass, credit shelter,
or unified credit trust.
Spouses commonly use mirror bypass trusts to double the value of property that can be passed to their heirs free of estate tax. Basically each partner’s trust creates a two-step process, providing income to the surviving spouse during his or her lifetime and then passing along the principal free of estate tax to permanent beneficiaries, typically the couple’s children or perhaps children from a previous marriage. Those assets are not included in the estate of the second person to die.
The terms of the trust specify that it will be funded from estate assets up to the tax-exempt limit that applies in the year the grantor dies. To ensure that can happen, each spouse must own enough assets in his or her own name. Since married couples who are both U.S. citizens can give each other assets of any value at any time without gift taxes, dividing up marital property to make two bypass trusts possible is part of the estate planning process.
To avoid taxes at the second death, the trust must meet certain legal requirements including giving the spousal beneficiary only a limited right to withdraw principal. The spousal beneficiary can, however, receive all of the income the trust generates.
Because these trusts can be complicated, and at the same time if executed correctly can reduce potential taxes substantially, you’ll want to make sure that you seek the advice of an experienced estate planning attorney to draft the documents.
The terms of the trust specify that it will be funded from estate assets up to the tax-exempt limit that applies in the year the grantor dies. To ensure that can happen, each spouse must own enough assets in his or her own name. Since married couples who are both U.S. citizens can give each other assets of any value at any time without gift taxes, dividing up marital property to make two bypass trusts possible is part of the estate planning process.
