I remember when my sister, as a young girl, would play with my grandmother’s collection of matryoshka dolls. Those are the wooden dolls, commonly known as Russian nesting dolls, of decreasing size placed one inside of the other. The outer layer is usually the painting of a woman wearing a dress and a babushka with figurines inside that are either male or female characters with the smallest usually looking like an infant carved out of a single wood chip.
The matryoshka doll is a good analogy for an estate planning technique that attorneys frequently use but that many of their clients don’t quite understand – the “testamentary trust”.
Think of a “testamentary trust” as the inside doll of one larger than it. The “outside” or main element is usually a will or a revocable living trust. If I create the Craig Hersch Revocable Trust, then that is the biggest matryoshka doll. Inside of my main doll might be a bunch of smaller dolls, the “testamentary trusts”.
When the grantor of that trust dies, the next inside trust comes out – which is a testamentary trust. “Testamentary” refers to “after death” meaning that the revocable trust may split into one or more testamentary trusts that can continue on for a period of years or the lifetime of their beneficiaries who follow the person who originally created the trust.
Let’s say that Ronald creates a revocable living trust. At his death, a testamentary marital trust is created for and benefits his wife Tiffany for the rest of her life. When Tiffany dies, two more testamentary trusts are created to benefit their children, Ron Jr. and Kathleen. Like the matryoshka doll, the trusts keep dividing.
But the testamentary trusts are not new trusts that require new language. They always existed inside of their parent trust but didn’t spring into life until the trust before them dies or is taken apart so that the new trust becomes the governing language.
Many people, including those who work in the financial services industry, get confused by testamentary trusts. When Ronald dies, for example, my office might call the bank and tell them to change the account to the marital trust created for Tiffany. It’s easy for them to get confused. “Where is this marital trust?” they might ask. Or, “we need a copy of the marital trust” when, in fact, they always had the copy of the marital trust because it was already embedded inside of Ronald’s trust, which they knew about from the beginning!
As each testamentary trust is established, the title on the accounts changes and a new taxpayer identification number is obtained. Like the matryoshka doll, it’s a new trust that came out from inside of the old one but is a completely different “person” in that it might have different provisions and beneficiaries. That is why the banks and brokerage houses have to change the title to the accounts that are now divided between the testamentary trusts.
You might wonder why anyone would use a testamentary trust to begin with. Why don’t you just divide all of your estate and leave everything outright to your children? Testamentary trusts are useful in that they can serve to protect the assets that you are leaving your children from the threat of a divorcing spouse, creditors and predators.
Assume the example where a son got foreclosed and the bank obtained a deficiency judgment on the mortgage balance. If you leave an inheritance outright to him, the bank may be able to force collection on their judgment. Another example would be your daughter the doctor who is in the middle of a malpractice case when you die. There, the inheritance you leave her might be at risk. Testamentary trusts can be built to mitigate these problems.
In years past, testamentary trusts got a bad rap. Many named banks as trustees that didn’t perform well or were loathe to distribute any of the money to the trust beneficiaries. Those days are past. A good estate planning attorney can draft a trust that gives its beneficiaries control over the investments and distributions of the trust. We can also draft provisions that allow a corporate trustee to serve alongside and be replaced by your selected trustee.
Testamentary trusts can also be drafted to accomplish income tax savings amongst its beneficiaries that cannot otherwise be achieved when an estate is distributed outright. There are all sorts of benefits to drafting testamentary trusts inside of your revocable trust or will, and many of these benefits have nothing at all to do with estate taxes.
So when your attorney starts talking about the use of a testamentary trust, think about the old wooden matryoshka dolls. They’re not quite as beautiful or as much fun, but they can sure add some life and good benefits to your estate plan.
©2019 Craig R. Hersch. Originally published in the Sanibel Island Sun.