Many estate plans provide for the creations of trusts after death for the benefit of a surviving spouse, children or charity. This article discusses some of the issues that arise when funding these “testamentary trusts,” whether created under a will or a revocable trust.
Funding a testamentary trust requires the transfer of assets into a new account in the name of the trustee named in such trust. For example, “Acme Trust Company, as Trustee of the Marital Trust under the will of John Smith”. A new taxpayer identification number is required, but easy to obtain.
With respect to estate assets, a testamentary trust cannot physically be funded until the estate assets are gathered. Different rules apply to funding a testamentary trust, which depend upon the type of trust created. There are essentially two broad categories of trusts to consider: Pecuniary trusts and residuary trusts.
A pecuniary trust is a gift of a specific amount of money. For example, “I give $ 100,000 to my Trustee, to hold in trust for my children”. Often, pecuniary gifts are expressed by use of a formula. For example, “I give to my Trustee the maximum amount that can pass free of tax at my death by virtue of the unified credit.” Even though no dollar amount is specified, this is a pecuniary gift that is determined based on information available at the date of death.
After funding pecuniary gifts, and after paying debts, taxes and expenses, the amount of property left in an estate (or revocable trust) is called the “residuary.” The residuary estate often is held in trust following the completion of estate administration. The primary advantage of a pecuniary trust is the ease of administration. The executor of an estate or the successor trustee of a revocable trust can fund the trust by transferring cash or assets having a specific value to the trust. If assets are distributed in kind to satisfy the pecuniary gift (shares of stock, for example), these assets are usually valued as of the date they are transferred to the trust. The executor or successor trustee can choose which assets to use to fund a pecuniary trust.
When an executor or successor trustee uses assets that have grown in value since the date of death to fund a pecuniary trust, the estate incurs a capital gain upon the funding. The effect is the same as if the assets had been sold and the cash proceeds used. Accordingly, the personal representative or trustee must be mindful of the potential tax impact upon funding a pecuniary trust.
A pecuniary trust is frozen in value as of the date of death, while the residuary trust fluctuates. If the funding of the pecuniary trust is deferred while the value of the assets decreases, the residuary trust will suffer. In large estates, the potential growth, or decline, of the residuary can be dramatic if there is a large pecuniary trust. Thus, it is important to analyze the various options available for funding trusts after a testator’s death, as the funding decisions may have critical impact on tax planning and on the interests of beneficiaries in the testamentary trusts.