What is the difference between a Testamentary Trust and a Living Trust?

Aug 1

A Trust can be established either during a person’s life (a “Living Trust”) or at his or her death by being included in a person’s Will (a “Testamentary Trust”). Both types of trusts have the benefit of allowing the creator of the Trust (sometimes called the donor, grantor, or settlor) to put in place a system of rules and procedures to properly manage the assets of the Trust while providing benefits to the creator’s intended beneficiaries (generally, his or her children).

Being able to name a Trustee that can manage property on behalf of beneficiaries is especially important if the creator has beneficiaries that may not be capable of managing the property due to their age, disability, or poor financial habits. A Trust may also provide asset protection and tax savings if drafted properly.

So, why would one choose one type of trust over the other?

Today, the Living Trust appears to be much more popular than the Testamentary Trust for several reasons.

Avoid Probate - the Living Trust allows property to avoid probate, which can be a costly and time consuming process, whereas the Testamentary Trust is created through a Will which has to go through probate to be validated.
Privacy - as a consequence of being created by a probated Will, a Testamentary Trust becomes a matter of public record which may raise privacy concerns. Third, the Testamentary Trust requires the Will to be valid in order to be established, which makes the Testamentary Trust more vulnerable to attack since it can fall under a Will contest or fail due to an improperly executed Will.
Increased Risk of Contest - having a public Testamentary Trust may create tension among family members who were not included as beneficiaries in the Trust (or who disagree with its provisions for whatever reason). It is also important to note that in the past a Testamentary Trust was subject to the continuous jurisdiction of the court and annual court accountings were required, but that is no longer true under the new MUTC.
Timing - The timing of when the Trust goes into effect is also a key factor to think about. A Living Trust goes into effect as soon as it has been signed and dated with your attorney. A Testamentary Trust only goes into effect upon your passing since it is part of your will.

However, to be fair, there are a few arguments for the Testamentary Trust:

(1) if you want the court to supervise the creation of the trust or make it public;

(2) if you don’t like the idea of having two separate documents to safeguard (i.e., your Will and Living Trust);

(3) you somehow convinced an attorney to draft a Testamentary Trust into your Will without charging you as much as he or she would have for a Living Trust (something that’s likely to cost you more in the end).

There is also an interesting Medicaid loophole that allows you to protect your assets from the nursing home by having a trust created through your will rather than your trust. In other words, if you predecease your spouse and your assets are held individually at death, then (based on current law) you can have those assets held in a testamentary trust be used for the benefit of your spouse without having such assets be countable for MassHealth / Medicaid purposes.

This testamentary Medicaid trust is different than an irrevocable living Medicaid trust because it’s triggered upon your death, doesn’t have the 5 year lookback, and allows the trustee to provide principal and income to the beneficiary (in the trustee’s absolute discretion) - whereas a living irrevocable trust doesn’t allow access to principal under the “any circumstances test”