When a grandparent does estate planning, they often wish to provide for their grandchildren’s education. The grandparent may want to ensure that funds left for grandchildren are used to cover the expenses of college and nothing else. To achieve this result, a grandparent can create a testamentary trust as part of their will.
An attractive feature of a testamentary trust when used for this purpose is that it enables a grandparent to essentially “rule from the grave.” The trust can stipulate that a grandchild will be able to access the trust’s assets only if engaged in the pursuit of a college education and will be able to use funds only for college-related expenses.
What Is a Testamentary Trust?
A testamentary trust is a trust created by a will. The trust is not established or activated until the grantor (the grandparent) dies. In the will, the grandparent includes a special section that expressly creates the trust. The assets to be placed in the trust are identified and a description of the intended use of funds is also provided.
A testamentary trust involves three parties. The grantor or settlor is the person who creates the trust in their will in order to transfer assets posthumously. The beneficiary is the person or entity who is to be the recipient of assets. The trustee oversees the trust and manages the assets until the beneficiary becomes responsible for them. A testamentary trust expires when the beneficiary receives the assets. A probate court is involved to ensure that the trustee is managing the trust as stipulated by the grantor.
As grantor of the testamentary trust, a grandparent can change its terms at any time before they die by making changes to their will. However, once the grandparent dies, the trust becomes irrevocable and can never be changed. The will goes through probate — the legal process of administering a decedent’s estate — during which the probate court monitors its administration until the trust has performed as intended on behalf of the grandchild. Since the terms of the trust are to be carried out after the grantor’s death, the choice of trustee is important. This person has a fiduciary duty to carry out the grandparent’s wishes exactly as outlined in the trust.
Options in Testamentary Trusts
When a grandparent decides to set up a testamentary trust for a grandchild’s college education, he or she must stipulate how the assets are to be used. The terms of the trust can be as flexible or restrictive as the grandparent desires. The grandparent may choose to limit the use of funds only to payments for tuition, books, and room and board as they come due. As an alternative, the grandparent may stipulate that a single lump sum be distributed to the grandchild upon their initial enrollment in college. A grandparent may also choose to distribute a fixed amount at the beginning of each year and let the grandchild decide when and how to spend it on college costs. He or she may specify that funds will only be distributed by the trust to the grandchild if he or she enrolls in a public institution, attends their alma mater, or majors in physics. The grandparent, as grantor, calls the shots.
A grandparent should include a clause in the trust that resolves what is to happen if a grandchild doesn’t go to college. In such a case, the grandparent may require that the assets be distributed to the grandchild on their 30th birthday. He or she could stipulate that failure to attend college results in forfeiture of the assets in the trust, which would then be distributed in a different manner also described in the trust.
A testamentary trust can be designed to benefit either one grandchild or two or more grandchildren. To prevent an older grandchild from reducing the trust disproportionately to the detriment of younger grandchildren, “equalization provisions” in the trust are recommended. The trust may contain provisions that allow the breaking of a trust that’s for the benefit of two or more grandchildren into separate trusts designated for the benefit of each individual grandchild.
Advantages and Disadvantages of Testamentary Trusts
The major benefit of a testamentary trust for college is that it gives the grandparent total control over when, how, and for what purpose assets are distributed. This is especially helpful to grandparents who have young grandchildren. With a testamentary trust, assets can remain protected until the child is old enough to be financially responsible.
A testamentary trust can be funded with life insurance proceeds after death. To do this, the grandparent must list the beneficiary of the life insurance policy as the trustee. Then, when the grandparent dies, the life insurance policy will pay into the trust.
While a testamentary trust has low upfront costs, fees from probate court can add up. The trustee needs to meet with the probate court annually until the beneficiary receives the assets. If the trust lasts many years, court fees can consume a significant amount of money.
Leaving the establishment of a trust to occur after death can be problematic. The designated trustee may be unsure how to interpret the provisions of the trust and cannot obtain clarification. Hence, the trustee may not want the responsibility. In this case, a family member may be appointed by the court as a replacement trustee. This might be contrary to what the grandparent would have wished. Therefore, it’s advisable that a grandparent, while still living, be certain that their designated trustee is ready, willing, and able to assume the responsibilities.
For someone who wants to create a trust and have control over asset disbursement, it may be in their best interest to create a revocable trust while alive. It’s easier to discuss matters with other parties and make any appropriate changes with a revocable trust. Plus, revocable trusts aren’t subject to probate since they’re created outside of a will.
It’s a common belief that testamentary trusts are useful only to the wealthy. In fact, they’re beneficial for people in a wide range of circumstances. A testamentary trust is one option for funding a grandchild’s college education that grandparents may choose. However, there are other types of trusts that are also effective in preserving assets for a college education that should also be considered.