Monthly Archives: August 2010

Creating a Testamentary Trust For Your Children

Do you have a viable financial plan in place if you die and leave your minor children behind?  You should review the status of your assets and your life insurance – how much money will be available?  Is this amount adequate or is additional life insurance coverage needed until your children are grown?  If you have minor children, even leaving them all of your assets and life insurance benefits is simply not enough.  Someone must handle the money that will be left to your children.  This should be a person who will invest and spend the money as you would under the same circumstances, and more importantly someone you choose.

Many parents provide for the children’s financial future through a Testamentary Trust (or through a children’s trust within a revocable living trust).  A testamentary trust is a trust created by the terms of a Last Will and Testament and does not become effective until your death.  It is literally a trust within a Will.  A testamentary trust differs from an inter vivos trust or living trust.  Such trusts come into being during your lifetime.  A testamentary trust is not funded until after death.  There is no need to transfer title to any assets during your lifetime.  The testamentary trust only goes into effect if you die before a child reaches the age the parent or parents have designated for him or her to receive all of the trust assets.

The person you name to invest and distribute the assets in a testamentary trust is called the trustee and your child is the beneficiary.  The trustee is usually the person you appoint as the guardian to your children, but it can be someone else you appoint instead.  The trustee is bound by the terms of the trust and has a fiduciary duty to act in the best interest of the beneficiary.  The trustee cannot mishandle the property or use the property for his or her own benefit.  You can state at what age you wish the trustee to distribute all or part of the principal to your children (e.g., one-half at age 25 and the remainder at age 30).  You can also designate your child as a successor trustee once the child reaches an appropriate age.

What Happens if you do not have a Plan in Place?

If you as a parent do not designate someone to handle your children’s assets in your Wills or your revocable living trusts, the court will have to make the appointment without direction from you.  If the court appoints a guardian or custodian to manage your children’s affairs, that person will be supervised by the court and will have to seek court approval for major expenditures.  The funds will be divided equally among the children – for administration by the guardian or custodian.  The remaining assets will be distributed to each child when he or she turns 18 unless otherwise directed by the court.

In Washington, the courts generally have four options when directing the distribution of estate funds to a minor if you die without a Will or without adequate provisions for a minor child.  The four options are as follows:

            A.        Blocked Account.  The money may be placed with a bank or trust company (insured financial institution) in an account for the benefit of the minor beneficiary.  Withdrawals may be made only upon court order.  When the minor beneficiary reaches age 18, the funds are distributed outright to the beneficiary.

            B.        Guardianship.  Prior to the closing of the probate, a guardian may be appointed for the minor and the property is then distributed to the guardian to administer as a guardianship estate.

            C.        Custodial Account.  The property may be distributed to a custodian for the minor under the Uniform Transfer to Minors Act.  The court will appoint the custodian if one is not named in the Will.  The court will then set the parameters for investment and distribution decisions from the custodial account.

            D.        Irrevocable Trust.  On occasion, the court may direct the transfer of the property to a court established trust for the benefit of the minor.  A guardian ad litem is appointed by the court to review the appropriateness of a trust and the possible terms of the trust.  By court order, the court approves the terms of the trust and the age at which the remaining assets in the trust are distributed outright to the beneficiary.  The court retains jurisdiction over the trust with the trustee providing annual reports to the court.  Many times, the court will extend the life of the trust past the minors 18th birthday to up to 25 years of age.  At that time, the trust terminates and the beneficiary receives the remaining assets outright.

Advantages of a Testamentary Trust

  • A testamentary trust can postpone payment of an inheritance well beyond age 18, in some cases lasting for the lifetime of a child.  The trust can provide for changed circumstances, such as educational, business, or travel requirements.
  • You are able to pick the trustee.
  • Unlike a guardianship or custodial account, a testamentary trust generally need not be subject to court supervision.  This reduces the cost, complexity, and difficulty associated with managing the child’s estate.
  • Unlike guardianships and custodial accounts, parents can decide exactly what standard should govern how the trust assets are managed and invested.  Furthermore, parents are given flexibility in how the trust will provide for their children.  This ability to customize the trust enables the trustee to make financial decisions similar to the way a parent would if the parents were still living.
  • A testamentary trust can specify alternative beneficiaries if the child is no longer living by the termination date.
  • Finally, a testamentary trust can be optimized to decrease taxes and expenses.  A guardianship does not have the same flexibility.

Options with Testamentary Trusts

Many parents would prefer for their assets to be held in trust for their children until the children reach 25 years of age or older.  Often parents prefer to have a combined pool of assets for the children, instead of separate equal shares.  This can account for the different needs of the children.  A testamentary trust can be established as a “pot trust,” (sometimes referred to as a “pooled trust”) meaning that assets can be pooled for the use of multiple beneficiaries.  A pot trust is particularly advantageous when the parents’ estate is not large enough to justify a division into separate trusts for each child.  Moreover, a pot trust can provide for greater expenses incurred by one child (such as a sickness or education) without wiping out that child’s inheritance.  On the other hand, testamentary trusts can also be divided into separate trusts for each child if the parents so choose or the circumstances warrant.

These goals can be achieved through a testamentary trust or a revocable living trust, but not through a custodial account or guardianship supervised by the court.

Often, parents who have a testamentary trust pass non-probate assets into a trust.  This is an effective and efficient approach.  The proper designation of beneficiaries in a life insurance policy or on a retirement plan can transfer the assets first to the surviving spouse.  If the spouse does not survive, the second beneficiary can be the trustee of the testamentary trust, thereby sending the funds directly into the trust for the benefit of your children.

If a trust is not established to receive the life insurance proceeds, and if the life insurance beneficiary designations are not properly established to fund the trust, the court will be obliged to appoint a guardian or custodian to handle the children’s funds.  This is often more cumbersome, more expensive, and less compliant with the parents’ wishes than a trust (and handpicked trustee) would be.

In many circumstances, a testamentary trust is the best answer to a parent’s need to provide certain financial protections for their children should both parents die prematurely.

Call the Law Office of Gary E. Gill, P.S. at (206) 621-1600 if you need further information regarding this subject or estate planning in general.

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