Comparing Testamentary and Living Trusts

  • Is it valid to compare a simple will to a living trust-centered estate plan?
  • What are the similarities between living trust-centered planning and testamentary trust planning?
  • What are the differences between living trust-centered planning and testamentary trust planning?
  • Is living trust-centered planning preferable to testamentary trust planning?

In most instances, trust critics compare living trusts to simple wills. Comparing a people-oriented living trust-centered estate plan to a simple will is like comparing a motor vehicle to a bicycle and then saying the latter is less complex and therefore better. It is a comparison that is not relevant.

A simple will distributes property outright only to heirs. Simple wills almost always contain language that says, “To my spouse if living, and if my spouse is not living, then to my descendants per stirpes’’. Simple wills do not provide for tax planning or include instructions for loved ones. If a simple will is compared to a living trust, the living trust is better for virtually all planning purposes. An argument can be made that a simple will has a few minor advantages, but even these advantages quickly disappear when testamentary trust planning and living trust planning are compared. To level the playing field, it is critical that the debate ultimately be focused on the testamentary trust versus the living trust. When this comparison is made, the distinctions and similarities between them become readily apparent.

A testamentary trust is a trust that is created by a will. A testamentary trust does not have an independent existence until after the death of a will maker and receives property only at the death of the will maker. Once it is created by a will, a testamentary trust functions exactly the same but for one important feature: A testamentary trust can be subject to the Estate winding up process for part or all of its existence. A living trust is not subject to this either during the life of its maker or after his or her death.

Most practitioners prepare wills as loss leaders that become an estate winding up which, like an annuity, will generate future fees. There are a number of estate practitioners who routinely prepare wills that create testamentary trusts for minor children and affluent couples with taxable estates. The more sophisticated planning practitioners create trusts for children and descendants with extensive wishes. A major difference between living trust lawyers and will planning/ Estate lawyers is in their opinion about when trust planning should begin. Should it come into effect immediately or only upon death? Will-planning/ Estate advocates would argue that death is soon enough for a trust to come into existence. Advocates of living trust-centered planning would argue that a trust cannot be instituted soon enough.

Regardless of whether a practitioner uses living or testamentary planning, there is little or no difference in time he or she will spend with a client or in the preparation of the appropriate documentation. If two identical clients respectively sought the services of an Estate lawyer and trust lawyer, they would theoretically be billed the same amounts for their consultations.

Each attorney would have to analyse each client’s situation carefully by gathering complete personal and financial information. Each attorney would enter into a dialogue with the client in order to exchange information and would familiarize the client with the law as it pertains to the client’s situation. Each client would familiarize his or her attorney with personal goals, objectives, beliefs, and biases.

Both attorneys would draft documentation to meet the client’s planning needs and desires. Identical planning would take place but for the choice of legal delivery vehicles. The Estate lawyer would use a will, and the trust practitioner would use a living trust plan. Each would draft ancillary documentation. The living trust lawyer would also create a simple pour-over will as a legal failsafe mechanism.

Each attorney would explain the documents so that the client could judge whether they met all of the agreed upon objectives and would supervise the signing and witnessing of the documents.

Both attorneys would then have to make title changes to their clients’ affairs so that their respective planning would control the appropriate assets. The will-planning/ Estate practitioner would want the title in the client’s name; the living trust practitioner would want it in the name of the client’s trust. This might entail new deeds to property, changes to the title of securities, or title changes to other property. Both practitioners would be sure that all beneficiary designations were changed so that the testamentary or living trust was the named beneficiary.

In either case, the client would generally participate in the title changing process. It is likely that the client’s other advisers, including life insurance agents, financial advisers, and accountants, would offer their assistance to the attorney in rearranging the client assets. As the client, the attorney, and the client’s other professional advisers worked together, the client’s assets would be arranged so that the operative planning document would control them.

What real difference is there in the practices involved in establishing a testamentary trust plan and a living trust plan? The answer is, very little. The living trust plan requires that the property be titled in its name; a testamentary trust requires that it be titled in the will maker’s name. The differences in the costs of initiating and preparing the respective plans may not be significant. However, funding a living trust is almost always more time consuming than rearranging the title to a will maker’s property. If the client chose not to fund his or her living trust immediately, the costs of living and testamentary trust planning could be theoretically similar.

But why wait to fund the trust? In essence, funding a living trust is Estate planning one’s estate now instead of waiting until death or disability. Some of the reasons given for not funding a trust are that the clients are just not old enough to justify the cost of funding, that funding now would be too much trouble, or that funding should be done only when the client has more assets. Obviously, each of these is an excuse rather than a reason. Since none of us know when we may become disabled or when we are going to die, there is no reason to delay proper planning.

Although creating a living trust without funding is not the best and most responsible estate planning method, unfunded trusts often exist. There are vital primary reasons as to why even an unfunded living trust plan is superior to a testamentary trust plan:

  1. The Master of the High Court’s supervision of the post death trust administration is avoided.
  2. Everything is pooled together under one document, giving the maker much more planning.
  3. Liquidity is placed in the proper hands so that expense, claims, and taxes can be paid with less complication and disruption.
  4. If the maker becomes incapacitated, the trust is available to be used without the need for a financial curator.

The Relevant Differences between Living Trusts and Testamentary Trust Planning

To this point there is a similarity between testamentary and living trust procedures. But, there are differences!

Estate Winding up

Before a testamentary trust can become operative, it must go through an estate winding up process, a living trust avoids this. Winding up fees can be substantial. When executor fees are added to these attorneys’ fees, the difference in the costs of living trusts and testamentary trusts can be even greater. A married couple who relies upon testamentary trust planning can generate two estates – one on the death of each spouse – with respect to the same assets. Testamentary trusts are far more expensive than living trusts because living trusts do not go through the estate winding up process.

Trustees’ Fees

Both testamentary and living trusts generate continuing trustees’ fees after the death of the decedent if paid trustees are named. In a testamentary trust, the trustees’ fees begin after death. Even though a living trust is created during the lifetime of the maker, it rarely generates current trustees’ fees because trust makers typically assume this function. Like testamentary trustees’ trust fees, living trust trustees’ fees, if any, generally begin after death.

Disability Planning

A testamentary trust is not a lifetime planning instrument and cannot be used to protect the maker from the problems associated with disability. Attorneys who prepare powers of attorney in conjunction with testamentary planning do not provide the same degree of disability protection that can be achieved by combining them with living trust-centered estate plans. Disability planning can be accomplished with living trust planning; no disability planning can be accomplished with a testamentary trust.

Delays in Administration

Testamentary trusts go through estate winding up and this creates delay. A testamentary trust does not automatically spring into full operational existence upon a person’s death. The assets of the decedent’s estate must be wound up into the trust. Because of the winding up’s many requirements, the executor will seldom make timely distributions immediately after death. Lengthy winding up can prevent a testamentary trust from being fully funded for several years after the death of the will maker. Delay will be exacerbated if there are disputes with creditors or if a disgruntled heir contests the will. It can also take several years before testamentary trusts can be properly funded if estate tax issues are involved. These events are apart from the fact that the estate’s executor must take time to locate and value the decedent’s property and notify and pay creditors, tasks which can be formidable in even small estates.

During the estate winding up hiatus the beneficiaries are not entitled to distributions of the estate’s assets. Family needs will have to be satisfied by assets such as life insurance that were kept outside the deceased estate or by miserly statutory allowances.

A living trust comes into existence the day it is signed. Its terms and conditions continue for the benefit of its beneficiaries on the incapacity or death of its maker. There is absolutely no delay when either of these events occurs.

Privacy and Confidentiality

The terms of a testamentary trust are a matter of public record and are open to the inspection and scrutiny of anyone. Every transaction that is required to be filed with the Master of the High Court is also a matter of that estate’s public record. This is not the case with a living trust.

Will and Trust Contests

If a will containing a testamentary trust is found to be invalid, the trusts created within it are also invalid. Wills are not difficult to attack, which means that the testamentary trust planning within them is equally vulnerable. A will contest can delay the creation of a testamentary trust for long periods because the very existence of the trust is expressly contingent on the will’s validity. Testamentary trusts are subject to susceptible continuing litigation. Living trust litigation is far more difficult to initiate.

Protection from Creditors

Testamentary trust property is subject to the claims of the decedent’s creditors. It is not uncommon for a testamentary trust to be named as the beneficiary of a life insurance policy on the life of a will maker. Life insurance proceeds are typically paid quickly. Yet a testamentary trust may not come into existence for some time. In this case the proceeds might have to be paid directly to the estate, destroying the creditor-free nature of the assets. A living trust does not suffer from these problems. After a trust maker’s death, a living trust totally cuts off the claims of all the maker’s unsecured creditors. Since the living trust is in existence at its maker’s death, third-party beneficiary contract proceeds can be paid directly to the trust free of the claims of creditors.

Conflicts of Law

The result of having the laws of different jurisdictions determine not only the validity of a will but also the way its terms will be interpreted can be devastating. If a dispute arises out of a testamentary trust and property is owned in more than one jurisdiction, the resulting litigation will involve conflicts of law that will likely be complex.

Lifetime Income Tax Issues of Funding a Living Trust

A testamentary trust does not come into existence until the death of its maker and therefore has no lifetime income tax issues. It is funded after the death of the will maker as part of the estate winding up administration process. Until then no real funding issues arise. However, the after-death funding of a testamentary trust can be a complex, time consuming, and difficult process.

A living trust should be fully funded. It is far less expensive and time consuming to face funding issues while a person is alive and well than to wait until he or she is disabled or dead. The ability to fund a trust while the maker is alive is a great advantage of living trust planning. Funding a trust is not a planning obstacle; it is a planning benefit.

Distribution Tax Issues

No distribution tax problems are associated with testamentary trusts because they do not come into effect until after the death of their makers. Distributions can be made from living trusts without problems if appropriate SARS guidelines are followed. A distribution program that survives the giver’s incapacity can be appropriately structured; this is best accomplished through the use of a living trust.

Continuity in Business Affairs

When property must be administered as part of the winding up of an estate process, the continuity of the decedent’s affairs will be disrupted. Disability and death do not have to be disruptive in terms of bringing all of the decedent’s business and financial activities to a halt. Because living trustees and their successors are the legal title holders of the trust assets, the death or incapacity of the maker, the beneficiaries, or the trustees will not affect the continuity of the trust.

Testamentary vs Living Trust

One assumes that there must be some rationale for the use of a testamentary trust over a living trust, but no one has yet provided a plausible argument which can withstand serious scrutiny.

DR MERVIN MESSIAS

JD (Juris Doctor) / BA, LLB (Wits) / TEP (Trust & Estate Practitioner) / MTP (Master Tax Practitioner – S.A)

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