Most trusts follow the same basic rules, although some can get a lot more complicated from there. They're legal entities that hold money and property for the benefit of those who will eventually inherit it. In the simplest terms, a trust is either revocable -- meaning the settlor or person who created it can change it at any time -- or it's irrevocable and its terms are carved in stone. If the beneficiary of a revocable trust dies before the settlor does, the settlor can simply rewrite his trust instrument to address the change. If the beneficiary dies after the settlor dies and the trust still holds property on behalf of the beneficiary, the property often passes to the beneficiary’s estate.
The Beneficiary’s Estate
When a deceased beneficiary’s trust inheritance passes to her estate, it’s subject to probate. The property is eventually distributed to her beneficiaries -- the ones she’s named in her will. If she doesn’t leave a will, it passes to her closest kin according to state law. In either case, it’s available to satisfy any debts she left. This happens when the trust doesn’t make any provisions for the possibility that the beneficiary won’t live long enough to accept her inheritance.
Revocable trusts distribute inheritances to their beneficiaries after the death of the settlor, then typically close down. This process can take a while if the trust is complicated, but it’s still a finite period during which the beneficiary would have to die before transfer of her inheritance to her estate or someone else would become an issue. It’s more likely to be a problem with irrevocable trusts, which can remain up and running for an extended period, before and after the settlor’s death.
If the trust instrument includes provisions for the death of a beneficiary, these terms would prevail. The trust might name an alternative beneficiary or beneficiaries; for example, it might state that if Mary dies, her trust inheritance would go to her children instead. This would prevent her inheritance from passing from her estate to someone of her own choosing -- perhaps someone the settlor wouldn't have wanted to receive a gift of his property. The trust instrument might say that if Mary dies, the inheritance she would have received will go to the other trust beneficiaries instead. Or it may give Mary power of appointment to state to whom she would like the trust to transfer her inheritance if she dies, rather than send it to her estate, where it would be subject to probate.
It’s a misconception that a trust can’t be contested or challenged as a will can, but it's usually a more complicated process. Grounds for a challenge remain largely the same, however. The challenger must prove that the settlor was unduly influenced or not of sound mind at the time he created the trust's documents. He might try to establish that if the settlor hadn't been influenced or had been of sound mind, he would have included different provisions in the trust instrument or included language that would have prevented the inheritance from going to the deceased beneficiary’s estate. This can be a significant burden of proof requiring the testimony of a mental health professional or comparable expert.