Testamentary Trusts in Florida

A common misconception in estate planning is that you have to choose between a trust and a will.

Although it is true that you can use inter vivos trusts (a/k/a living trusts) as an alternative method of distributing assets, trusts and wills are by no means mutually exclusive.  In fact, the two are often used concertedly, allowing an estate plan to accomplish goals that neither a simple will nor an inter vivos trust could achieve on its own.

PUTTING YOUR TRUST IN A WILL

A last will in Florida and other states generally lets you choose who inherits your assets after you’re gone, but, for the most part, you don’t get any say in what happens next.  So, if you bequeath a precious heirloom to a family member, after you die, he or she has the right to sell it to a pawn shop – even if it belonged to your great-grandmother and you really wanted it to stay in the family.  An inter vivos trust, a/k/a living trust in Florida, allows for some control over future possession and use of assets, but you have to give up legal ownership of the property for the trust to become effective.  By using a testamentary trust, though, you can retain title for the rest of your life and still get some say in how assets are used after your death.  Depending upon your goals, it could be the best of both worlds.

What is a Testamentary Trust?

A testamentary trust (sometimes just called a “will trust”) is simply a trust created by a will – as opposed to a living or inter vivos trust, which is established while the grantor is still alive.   The will devises some or all of the testator’s estate to the trust, which is then administered under terms established by the testator-grantor and set out in either the will itself or by incorporating a separate declaration of trust.  The trust names a beneficiary for whose benefit trust assets are held.  But, importantly, the trust itself is the named beneficiary of the will and technically inherits the assets.  If several beneficiaries are involved, a will can create more than one testamentary trust, or a single trust can have multiple beneficiaries (sometimes called a “pot trust”).

Testamentary trusts do not legally exist until after the grantor’s death, so they are, by definition, irrevocable.  However, the terms of the trust can be amended or revised – or the eventual trust can be completely rescinded – at any time prior to death by amending the will or codicil that establishes the trust.  Unlike some other irrevocable trusts, testamentary trusts do not remove assets from the decedent’s estate for either avoiding Florida probate or limiting inheritance taxes (a/k/a estate or death taxes).  Assets devised to the trust are part of the estate and descend to the trust in essentially the same way as any other assets bequeathed to individual heirs.

Once in the trust, assets can be gradually distributed to beneficiaries, invested for later distribution, or managed so as to earn income for later disbursal, or some combination thereof – whatever the grantor directs.  The arrangement can protect assets from being squandered by a wastrel heir or attached by creditors, and can also have tax advantages for beneficiaries.

How Does a Testamentary Trust Work?

If you want to create a testamentary trust, the first step is properly preparing a last will in Florida or your state of residence with all the necessary information.  The will states what property will descend to the trust, who will act as trustee, and who will benefit from the trust.  The executor named in the will is empowered to establish the trust and transfer title to all specified assets to the trust.  Alternatively, you could include provisions in an inter vivos trust creating a secondary trust upon your death.

Before a testamentary trust becomes effective, the estate must pass through probate.  As part of the probate process, the executor formally transfers property from the estate into the trust, and the probate court or commissioner officially appoints the named trustee.  The trustee can be more or less any mentally fit adult but should be someone who is financially competent and trustworthy.  Money-savvy family members, close friends, or trusted personal attorneys are common picks to serve as trustee of a testamentary trust.

Just as important as being competent, a designated trustee needs to be someone who is willing to serve in the role.  A named trustee can decline the appointment, or can resign or become incapacitated after being appointed, so the trust should name a successor trustee or include a mechanism for selecting a successor trustee if it becomes necessary.

Trustees have a fiduciary duty to act in the best interests of beneficiaries and the trust itself.  This can mean responsibly investing assets, maintaining real estate held by the trust, or even refusing requests for disbursals from a beneficiary who the trustee believes will waste the money.

Testamentary trusts can define distributions strictly or allow for substantial trustee discretion.  For instance, a more rigid trust might call for quarterly or annual distributions in a set dollar amount or as a percentage of trust assets, with little or no trustee flexibility.  Or, the trust could direct the trustee to distribute sufficient assets to provide for a beneficiary’s health, well-being, and education, and permit additional distributions for entertainment and vacations, subject to trustee approval.  It’s a good idea for the grantor and future trustee to discuss the trust’s objectives while the grantor is still around to avoid any uncertainty, particularly when the trustee is afforded considerable discretion.

Because a testamentary trust is created through the probate process, the court oversees the trustee’s administration of the trust.  Typically, the trustee is required to file an annual report and/or attend a hearing before the court to show that the trust is being administered in accordance with the grantor’s wishes and the trustee’s fiduciary duty.  Court oversight can be a big plus because it keeps trustees honest and helps ensure the trust is properly administered.  But the downside is that periodic reports and hearings add to the trust’s administrative costs, which can eat away at trust assets over time.

As with the other details, a testamentary trust’s terminus is spelled out in the testator-grantor’s will.  Commonly, testamentary trusts continue until the beneficiary reaches a certain age or life event, until trust assets are depleted, or until the beneficiary’s death.  Upon termination, the remaining assets (if any) are usually distributed to the beneficiary or his or her descendants, though it is not uncommon for any remainder of the trust estate to go to charity.

Why Create a Testamentary Trust?

Testamentary trusts allow you to control, delay, or spread out a beneficiary’s receipt of assets.  They are commonly used for the benefit of minor children or disabled heirs and are also useful in protecting a beneficiary from his or her own financial irresponsibility.  For children, a grantor might direct the trustee to make relatively small annual distributions and invest the bulk of the funds until the child reaches adulthood, graduates from college, gets married, or reaches another specific age or milestone.  For a disabled family member, a testamentary trust can be set up as a special needs trust in Florida, supporting the beneficiary throughout his or her life without jeopardizing Medicaid or SSI eligibility.

If you’re worried that your intended heir lacks the financial discipline to manage a lump-sum inheritance wisely, you could use a testamentary trust to provide long-term support without risking rapid asset depletion.  While leaving asset-management to a capable trustee, a trust could provide periodic disbursals and authorize additional distribution requests for emergencies, vacations, or luxury purchases, to be approved or rejected at the trustee’s discretion.  A secondary advantage is that a trust helps protect assets from a beneficiary’s creditors or loss in a divorce.  Although amounts distributed to a beneficiary are attachable, assets held within a trust are generally outside the reach of creditors.

Testamentary trusts can also be useful in reducing tax liability.  Assets devised to the trust are subject to the federal estate tax (if the estate qualifies), but, in states that impose an inheritance tax on heirs (not including Florida), beneficiaries of a testamentary trust usually avoid the tax.  Beneficiaries can also avoid big tax bills for capital gains or income earned by trust assets, though the trust itself may need to file a return.  By spreading out distributions over multiple tax years, a trust potentially allows a beneficiary to remain in a lower tax bracket.  Depending upon the amount of income earned and the effective marginal rate, the cumulative tax savings can be significant.  For this reason, grantors sometimes make testamentary trusts discretionary, allowing beneficiaries to choose whether to receive an inheritance directly or through a trust.

Testamentary trusts can be advantageous in many scenarios, but they are not appropriate for every estate.  If you are contemplating a testamentary trust as part of your estate plan, you should consult with an experienced estate-planning attorney for advice on whether a testamentary trust could work well in your situation.