What is a Testamentary Trust?

Testamentary trusts are probably the most common trusts of all. Of course they are not "living" trusts because they are activated by a will only upon the death of the donor. A spousal testamentary trust provides benefits to the grantor's spouse, usually for a lifetime. The spousal testamentary trust normally states that all income be paid to the spouse during his/her lifetime; that access to capital be granted at the trustee's discretion; and that after the spouses death, the assets in the trust pass to other beneficiaries outright or through another trust.

Often this type of trust is referred to as an "AB Trust" or ab trust or A/B trust. It also can be referred to as a credit shelter trust or bypass trust. With this type of testamentary trust, each spouse puts his or her property in the AB trust. When the first spouse dies, an appropriate amount (usually up to maximum estate tax exemption amount) goes to a trust (say the "B" for "below ground" trust) with named beneficiaries of the trust (usually the children).

The surviving spouse gets the rest of the property and usually also can use the property in the "B" trust during his or her lifetime and also receives income the property generates. Sometimes, the surviving spouse can even receive principal of the trust in certain circumstances.

However, the surviving spouse is not considered to "own" the property in the B trust and thus it is not included in the surviving spouses estate (for estate tax purposes) when he or she passes away. In this way, each spouse is able to use his or her estate tax exclusion to the maximum extent possible.

If the first spouse to die had simply left everything to the second spouse, then, the first spouses estate tax exemption would never have been wasted – resulting in more estate tax ultimately paid. [Of course this assumes the estate is over the estate tax threshold.]

In addition, some type of assets that do not produce income can be protected in this type of trust. For example, in order to maintain control of a family business, the assets can be controlled through a spousal testamentary trust. Other assets – such as a family vacation home – can be covered in this type of trust so that family members can use the property.

Finally, a spousal testamentary trust offers tax benefits not available in other trusts. For instance, capital gains can be deferred until the surviving spouses death.

Testamentary Trusts for Disabled Children

Q: My wife and I have a disabled child. We want to be certain she is provided for in the case of our death. We are considering Spousal Testamentary Trusts but also want to provide financial assistance to our child.

When the parents of a disabled child die, the benefits of a Testamentary Special Needs Trust (an example of a type of testamentary trust) can be advantageous. The trustee can distribute income for the care of the child. The trick is if you want the child to also qualify for Medicaid or social security, then it can get tricky. Read more about this at disability trust.

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