Testamentary Trusts – what are they?

Following on from Friday’s post where Colonel McKee left his estate in trust until after the death of his grandchildren for the purpose of establishing a school for orphaned children, I have been asked some questions about testamentary trusts.

Essentially a Will maker can leave a gift two ways:

• outright; or
• subject to certain conditions.

An outright gift enables the beneficiary to do what they like with it – this is usual where a person leaves property or an amount of money in a Will. However if there are any conditions imposed upon the gift by the Will maker it is effectively a ‘testamentary trust’.

The key elements of a testamentary trust are:

• Certain assets are singled out to be held in the trust, ‘trust property’;
• Someone is given control over the trust property, the ‘trustee’; and
• The trustee must manage the trust property (and its income) for the ‘beneficiaries’.

A testamentary trust is created by a Will (or a codicil to a Will); importantly to be valid, the Will must be valid.

The simplest type of testamentary trust is one that is created when you give a gift to someone that is held by the executor as ‘trustee’ until the beneficiary reaches a certain age. When the age is reached, the beneficiary will then receive the gift and the trust comes to an end.

However most people who talk about creating a testamentary trust in their will are thinking of something more sophisticated – think of Colonel McKee’s Will.

This kind of a protective trust enables the Will maker to control or influence the way the assets can be managed, used and accessed by their beneficiary.

They are often used where there is a concern that the beneficiary is unlikely to be able to manage their own financial affairs or are under the adverse influence of a third party; or the Will maker might want their assets to survive the beneficiary for the benefit of a subsequent generation.

The reason for this may vary depending upon the purpose of the trust; it may be to provide an income to the beneficiary, to allow for the education and maintenance of a beneficiary or both.

Commonly the trustees are other family members, lawyers, accountants or trustee companies.

The main reason to create a trust is to protect a gift. If the named beneficiary has a gambling problem, or has a history of making poor spending choices, the gift remains protected.

There can also be taxation benefits – although I am not going to discuss those here.

In a previous post I discussed Anna Nicole Smith’s Will where she left money to her son Daniel to be held in trust and distributed in three equal amounts when he reached age 25, 30, and the balance of the gift at 35.

A Will maker might leave this type of trust because if the beneficiary gets into financial trouble between 25 and 30 or 30 and 35 from a failed business or divorce only the assets they received at 25, or 30 are at risk; when they reach 30, or 35 they have another chance at properly managing this wealth.