Updated: Jan 5
Are you worried your beneficiaries will squander their inheritance? Or are you more concerned about the possibility that your beneficiaries may get sued in the future? Perhaps you are concerned that someone might want to marry your beneficiary for their inheritance or there is a possibility of a divorce? Maybe, you want to make sure that your beneficiaries do not have an additional tax burden due to their inheritance from your estate? Fortunately, there are ways you can protect your beneficiaries. One possible solution to this problem is a testamentary irrevocable trust.
A testamentary irrevocable trust is a type of trust that is only created upon a death. Instead of giving an inheritance outright (i.e. free and clear with no strings attached), you would be giving the inheritance to your beneficiary in trust for their benefit. You can add strings to the inheritance as long as those strings do not violate public policy. While the inheritance is in trust, it is protected from the following: your beneficiaries' poor decisions, their creditors, their predators, and from estate taxes. A testamentary trust also provides protections for future beneficiaries. You are able to decide who would receive the remainder of the Trust when your primary beneficiary passes away.
Poor Decisions. While the assets are in trust, the Trustee can only use those assets according to the terms of the trust. A typical provision for trust distributions is to provide for a beneficiary’s maintenance, education, support, and health. Therefore, if your beneficiary wishes to use trust assets to gamble, then tough luck. If your beneficiary wants to go to medical school, then the trust can pay for the tuition. If your beneficiary wants to purchase a 10-carat diamond ring for a brand new girlfriend, then too bad, your beneficiary can go get a job. You have control over what the trust can and cannot pay for. If you are concerned about your beneficiaries’ potential decisions over the use of funds, then you can plan for it now.
Creditors. If your beneficiary gets sued, then the assets of the testamentary trust are generally not included in the lawsuit, because the assets do not belong to the beneficiary. Instead, the assets are only available to the beneficiary to be used according to the terms of the trust, and paying off a creditor is not usually on the list of things a trust can pay for on behalf of the beneficiary.
Predators. If someone wants to marry your beneficiary because of an inheritance, then he or she will need to wait until the testamentary trust terminates. While the assets are in the trust, they do not belong to the beneficiary. If your beneficiary gets divorced, then the assets of the trust should not be included in the divorce because the assets in the trust do not belong to the beneficiary. The assets in the testamentary trust are only available to the beneficiary per the terms of the trust.
Estate Taxes. The assets of certain testamentary trusts are not included in a beneficiary's estate for estate tax purposes.
Future Beneficiary Protection. When your beneficiary passes away and there are still assets remaining in the testamentary trust, then you get to decide where those remaining assets go and how (i.e. outright or in another testamentary trust). For example, you can decide that when your beneficiary passes away, the remainder of the trust is distributed to the beneficiary's children, instead of their spouse.
While there are a lot of benefits in using a testamentary trust to protect a beneficiary's inheritance, there are also some drawbacks to this type of planning.
Fees. A testamentary trust will incur more fees than an outright distribution. There will be annual trustee(s) management fees. There will also be annual tax returns (Form 1041) and accountant fees.
Complex. A testamentary trust will be more complex to administer than an outright distribution. There will be the ongoing interaction between the trustee(s) and the beneficiary.
Reporting. The Washington Trust Act requires that the trustee(s) of a testamentary trust prepare an annual accounting to the primary and remainder beneficiaries.
If you want to protect your beneficiaries, then using a testamentary trust is a great tool to use. However, you will also need to weigh your goal of protection with the administrative costs of creating this protective tool. There is no right or wrong way to provide for your beneficiaries. Remember, this is your money. You get to decide what you want to do with it.
Keep reading upcoming newsletters for 2022 seminar topics, one of which will cover this issue. If you would like to learn more about testamentary trusts or would like to include a testamentary trust as part of your estate plan, please call Rehberg Law Group at 206.246.8772 to schedule a no-cost appointment.