Using Testamentary Trusts: Part Two-Protection Trusts

In my last post, I discussed the use of trusts under a Will (known as “testamentary trusts”) to delay, minimize or eliminate federal and state estate taxes.  Marital, credit-shelter and disclaimer trusts provide sufficient protection from excess taxation for many individuals and families.  In addition, these trusts can also protect the assets contributed to them from claims of creditors.

Another type of testamentary trust frequently used are trusts that are designed to protect and preserve the assets from waste or other concerns other than taxes.  These “protection trusts” may exist for a short period of time or may last the lifetime of beneficiary depending on why they are established.

When discussing “protection trusts,” I am referring to two specific types of testamentary trusts, namely:

1)   Descendants’ Trusts-In a typical estate plan, the children (and grandchildren) of a Testator are often primary or secondary beneficiaries of an estate.  If these beneficiaries are not old enough or mature enough to handle inheriting a large amount of wealth directly, a descendants’ trust can be used to preserve the assets while also providing the beneficiaries with access to the trust’s income and principal.

Descendants’ trusts can either be structured as one trust for all the children (and grandchildren) or as individual trusts for each respective beneficiary.  Income and principal distributions are made based on a standard of the Testator’s choosing.  A common standard is to allow distributions for a beneficiary’s health, education, maintenance or support.  The Trustee of the Descendants’ trusts would have discretion to determine when distributions would be made and how much should be paid or applied for the benefit of a specific beneficiary.

A Descendants’ Trust can continue for the lifetime of a beneficiary or may terminate at earlier age as chosen by the Testator.  In addition, the beneficiary of a Descendants’ Trust may given the ability to withdraw a portion of the Trust principal before the Trust terminates.  The Testator is given significant flexibility in determining when and if to terminate these trusts and whether to allow for partial terminations.

2)   Supplemental Needs Trusts-For families with children or other relatives on government assistance programs like SSI or Medicaid, the ability to leave an inheritance to their special needs relative requires additional care.  Because of the strict income and asset limits on the beneficiaries of these programs, leaving an outright bequest is not possible.  Instead, a special needs relative may receive a bequest through a supplemental needs trust.

The beneficiary of supplemental needs trust can receive distributions during their lifetime to supplement the services paid for by the government.  Examples include travel, entertainment and other products or services normally not paid for by the beneficiary’s benefits.  The beneficiary cannot have any direct or indirect control over when and how the distributions are made.

A supplemental needs trust continues until the death of its beneficiary.  A named remainder beneficiary will receive whatever remains in the trust.   The beneficiary has no say in determining who receives the remainder of the trust principal and undistributed income.

Like the tax based trusts, these trusts can protect the assets in them from the claims of the creditors.  Unlike those trusts, descendants’ trusts and supplemental needs trusts also protect the assets from waste by a beneficiary and protect a beneficiary’s benefits in the case of supplemental needs trusts.

Please contact for more information about testamentary trusts.



Using Testamentary Trusts: Part One-Tax Based Trusts

Property that passes under a Last Will and Testament is distributed in two distinct manners.  For those with minimal assets and concerns regarding taxes, asset protection and waste, an outright transfer of property is simplest and most efficient way to pass property.  But, in most situations, concerns about protecting the testamentary assets leads to the use of trusts established under the Will known as testamentary trusts.

Testamentary trusts come in two forms: trusts that are structured to delay, minimize or eliminate estate taxes and trusts used to protect the underlying assets from waste by a minor or disabled beneficiary.  Next week, I will discuss the latter type of testamentary trust.  Today, we look at the three main types of tax based testamentary trusts used by estate planners.

Marital Trust-The most common form of tax-based trust is established to take advantage of the federal and New York state marital deduction for estate tax purposes.  Under the laws of both the state and federal estate tax system, unlimited assets may be passed to a surviving spouse without incurring an estate tax.  Upon the death of the surviving spouse, the assets in a marital trust are treated as part of the surviving spouse’s taxable estate.

Marital trusts can be structured to provide the surviving spouse with a lifetime income interest as well as the ability to receive principal distributions.  Beyond tax savings, a marital trust can ensure that the assets in the Trust will be transferred to your children and not to any subsequent spouse if your spouse remarries.

Unlike the other testamentary trusts mentioned in this post, same-sex couples for New York estate tax purposes can now utilize a marital trust.  However, it should be noted that assets in a marital trust for a same-sex couple would be subject to federal estate tax under current federal law.

Credit-Shelter Trust-A distinct disadvantage of a marital trust is that the assets in a marital trust are subject to estate taxes after a surviving spouse passes.  For individuals and couples with assets in excess of the current estate tax exemption, it is possible to preserve a portion of their assets from estate tax even after the surviving spouse passes.  This is accomplished by using a credit-shelter trust.

A credit-shelter trust is funded with a portion of a decedent’s estate up to the federal or New York state estate tax exemption.  The surviving spouse receives the income generated by the trust property for their lifetime and can also receive principal distributions for their health, education, maintenance and support.  A decedent’s children may also be beneficiaries of the trust.

Upon the death of the surviving spouse, the remaining assets in the trust pass federal estate tax-free.  However, if the federal exemption were used, New York state estate tax would be due.  A secondary disadvantage is that utilizing a credit-shelter trust removes a certain amount of flexibility and therefore, it is not always the ideal strategy for individuals who have estates below the federal estate tax exemption.

Disclaimer Trust-For individuals and couples with assets below the federal estate tax exemption, it is likely that their estate planning will focus on funding a marital trust.  In some circumstances, assets can grow between the time an estate plan is enacted and the date the first spouse passes.  Even if a credit-shelter trust is not mandated under a will, using a disclaimer trust can allow a surviving spouse to receive similar benefits.

A disclaimer is a post-mortem (after death) planning technique by which a surviving spouse renounces some or all of their inheritance.  If a disclaimer trust were included in a will, the disclaimed assets would pass as if the surviving spouse had predeceased and the disclaimed assets would fund the disclaimer trust.

Assets held inside a disclaimer trust will pass estate tax-free upon the death of a surviving spouse.  The benefit of using a disclaimer trust over a credit shelter trust is that it allows the surviving spouse flexibility in deciding whether to preserve certain assets and shelter them from estate taxes after they die.   The disadvantage is that funding a disclaimer trust requires an affirmative step by the surviving spouse and additional paperwork will be required.

The use of tax-based trusts under a will allows a surviving spouse the benefit of their spouse’s assets while also preserving the maximum amount of those assets from excess taxation.  This benefit, coupled with the traditional benefit of using a testamentary trust, makes having one or more of these trusts included in your Will a very smart idea.

Please contact for more information about testamentary trusts.