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Personal Finance FAQ

Personal Finance FAQ: Should I Create a Spousal Testamentary Trust?

Last Will And Testament
This John Doe guy sure is popular!

“Die, v.: To stop sinning suddenly.”
–Elbert Hubbard

I recently had clients who were working on developing wills for their family ask me a question about creating a spousal testamentary trust and whether or not they (husband and wife) should create one.

If you’re using a standard online will creation program like LegalZoom, then you’ll probably come across this question:

Spousal Testamentary Trust.

Do you want the gift to your spouse to be held in trust?

If you answer “Yes”, your spouse can use the trust property during his or her lifetime. After your spouse passes away, the remaining trust property must go to the people you name later in the questionnaire.

If you answer “No”, your spouse will receive all of the property with no restrictions.

A spousal testamentary trust is one where, when the first spouse passes, instead of having everything in the estate pass to the surviving spouse, the assets pass instead into a living trust. Since the trust didn’t exist before the death, it is called a springing trust. The remaining spouse is named as a beneficiary, and usually, the amount available as income from the trust is limited. Additionally, a spousal testamentary trust must pass through probate and is subject to reporting from the court.

This means that the surviving spouse doesn’t get unfettered access to the assets of the spouse who just died.

Besides in the instance where you might have harbored a long-held grudge against the spending habits of the other spouse – in which case, you should have a deep discussion long before you reach the point of exploring the intricacies of the afterlife – there aren’t many cases where you’d want to provide a testamentary trust of any type. There are two which come to my mind:

  • To protect your assets from Medicaid. If you’re the healthy spouse and your spouse is in declining physical or mental condition and you don’t have adequate assets or a long-term care insurance plan in place, then chances are pretty good that your spouse is going to eventually wind up in a Medicaid nursing facility. In this case, you could use a testamentary trust to avoid having all of the assets being spent away in nursing care and having your spouse wind up in a Medicaid facility anyway. THIS IS A CHOICE OF LAST RESORT! Did I make that clear? Be proactive and take control of your future and get yourself in a position where this is not necessary. I have family experience with Medicaid facilities and with private facilities, and I have never seen a Medicaid facility that was better than a private facility. Avoid this route if you can, but if you’re too far down the road, this could be used to protect some assets.
  • Your spouse has disabilities to the point where he or she is not capable of taking care of his/her own needs. In this case, you’re creating a special needs trust, just as you would if you had a special needs child that you wanted to have taken care of after you pass. This will create a trustee whose responsibility is to make sure that your spouse is taken care of in the event of your passing.

Most states have a fairly simple process for establishing a trust via a will called the Uniform Custodial Trust Act (UCTA), so if your state has a standard Trust Act, then your bank will have appropriate documentation to set one up so that it is brought to life upon your passing (how ironic?).

If you’re looking to use a trust to avoid estate taxes, then there are better ways to accomplish it than by limiting your spouse’s benefits from the assets.

In either case, you’re best off speaking to a competent and qualified estate planning attorney if you think that you might need a trust.

Disclaimer: I’m not an attorney. I didn’t even sleep at a Holiday Inn Express last night. Please, please, please seek competent legal counsel before creating a trust.

By Jason Hull, CFP®

Jason Hull, CFP®, was the co-founder of Broadtree Partners, a firm that acquires $1-5MM EBITDA companies. He also was the co-founder of open source search consultancy OpenSource Connections, a premier Solr and ElasticSearch firm. He and his wife FIREd (financial independence retire early) at 46 and 45, respectively. He has a BS from the United States Military Academy at West Point and a MBA from the University of Virginia Darden Graduate School of Business.

You can read more about him in the About Page.

4 replies on “Personal Finance FAQ: Should I Create a Spousal Testamentary Trust?”

Kind of related: I think if you have minor children, then I think a testamentary trust is a necessity.

It is unlikely that you and your spouse will both die before all of your children reach 18. The problem is that if it does happen, it could be very difficult for their guardian to receive your life insurance proceeds, or even some of your assets. The safe bet is to set up a testamentary trust for the benefit of your children in each of your wills. Then you can name the trust, with the guardian as trustee, as secondary beneficiary (after your spouse) to your life insurance, 401k, and IRAs.

Since it is a low-probability event, you don’t need to go through setting up a living trust. A testamentary trust is cheap insurance against a bureaucratic nightmare for your family being added to a tragedy.

But back to your point, I know guy who will have most of his assets go into a trust when he dies. He is worried about his wife getting ripped off, so he wants his lawyer and/or another relative to sign off on major outlays from the trust.

There are many reasons for spousal trusts in addition to concerns about the surviving spouse’s spending habits or disability. Below are a couple of them:

Those with large estates can take advantage of bypass trusts. Under the new estate tax rules, a deceased spouse’s estate tax exemption is portable; however, that does not make bypass trusts obsolete. For example transferring assets to a bypass trust will ensure that the assets are sheltered from new spouses, creditors, or others who may sue the surviving spouse, whereas an outright distribution would not. The following article provides more information on situations when bypass trusts are helpful despite portability: Does Portability Make Bypass Trusts Obsolete?

Spousal trusts can also be beneficial in blended family situations. They allow a testator to provide for a surviving spouse during his or her lifetime and direct that the balance of the trust assets get transferred to children from a previous relationship upon the surviving spouse’s death. A testator relinquishes control of all assets left outright to a surviving spouse, potentially disinheriting children from a prior relationship.

An estate planning attorney can advise on whether a spousal trust will be beneficial depending on a client’s goals, objectives and unique circumstances.

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