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Testamentary vs Inter Vivos Trust Funds

Understanding the Difference

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Testamentary Trust Funds and Inter Vivos Trust Funds

The terms testamentary and inter vivos help you understand how a trust fund came into existence - after death, or during life.

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In the past, I've talked about how trust funds can be used for long-term compounding, building wealth for your heirs. In the world of trust funds, there are two broad types: Testamentary trust funds and living trusts, also known as inter vivos trust funds. The terms may sound complex but the meanings are simple. I'm going to walk you through both.

  • Testamentary trust funds are trust funds formed after death.
  • Living trusts, or inter vivos trusts as they are often called, are trust funds formed during life

A testamentary trust fund comes into existence upon the death of the grantor (the person establishing the trust fund), as prescribed in his or her will. The downside of this approach is that the assets used to fund the trust are almost certainly going to go through the probate process, which can possibly lead to outcomes that the now-deceased never desired, including seeing relatives you would rather not get any of your money fighting for a share.

For example, imagine a married couple with an estate of $2,000,000. They pass away and their will calls for all of their assets to be placed into a trust fund, at which point the cash will be invested in blue chip stocks. When their two young children turn 18, they will receive 4% distributions from the trust, split evenly among them. When they turn 30, they entire trust terminates and the money is distributed between the two beneficiaries equally. The bank that handled the family's financial affairs acts as an institutional trustee, investing the money and making sure compliance with the trust terms and state law are met. This is an example of a testamentary trust because the trust fund didn't exist until the parents died.

On the other hand, imagine this same married couple with an estate of $2,000,000. They decide to establish two trust funds for their sons, naming themselves as trustees, and gifting $100,000 into each fund. For now, the boys don't receive any distributions, but when they turn 18, the fund will begin to pay out 3% of its net worth each year to help with living expenses. From time to time, the husband and wife make additional gifts to the trust fund balances, increasing the amount of money working for each beneficiary. They can contribute cash or, in some cases, kick in other assets such as real estate investments. Families that own businesses would almost inevitably consider contribution equity in the limited liability company through which the firm was held. This is an example of an inter vivos trust because it was formed during the grantor's lifetime; there was no death necessary to trigger the creation of the trust itself.

Revokable vs Irrevocable Trust Funds

If a trust is revokable, it means the grantor can make changes to it during his or her lifetime. That is, generally speaking, the trust fund can be undone. The most popular form of this is known as a Revokable Living Trust, which offers a way to reduce estate taxes.

A living trust is unique in that one strategy used involves the grantor also serving as the trustee and beneficiary. This reduces the asset protections available, and takes away most of the immediate tax benefits, but can protect the elderly from abusive family or friends. By naming an institution or trusted advisor as the trustee, they can take over for you if you are incapacitated. Upon your death, the entire portion of the estate that was within the trust fund should sidestep probate and immediately begin benefitting the contingent beneficiary, which you named ahead of time. This can be anyone - your children, grandchildren, nieces, nephews, cousins, or a charity.

If a trust is irrevocable, it means that the grantor can't take the money or assets back once the trust fund is established. There are no "do overs" so you need to make sure it is structured correctly. The advantage of this sort of situation is that, all else being equal, it provides the most asset protection against creditors and adverse judgments because the property truly does not belong to either the grantor or the beneficiary.

Which Trust Fund Is Right For Your Situation?

Trust fund law is one of those areas where there is no substitute for qualified legal advice from a highly respected, competent attorney specializing in the field. Every state is different and, depending on your needs, every trust fund is different. This is not an area where you want to cut corners and try to save a buck because if you don't do it right up front, the lawyers will end up getting it after you're gone when your heirs are fighting over the assets.

For more information, read What Is a Trust Fund? to discover some of the common terms used in trust fund documents.

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