What is a testamentary trust?
A Testamentary Trust is a trust established under a Will, which only comes into effect after the testator’s death. A Testamentary Trust operates differently to a regular Will as a it includes a Testamentary Trust Deed which governs the management of the estate of the testator.
A Testamentary Trust holds all the assets of the testator whilst allowing for the management and distribution of the estate’s assets according to specific terms set out in the Will. Testamentary Trusts are often used to protect beneficiaries, provide for minor children, and manage assets efficiently.
Establishment of a Testamentary Trust
The testator’s written Will provides for a Testamentary Trust to be established after they pass. Unlike an inter vivos trusts, where the assets pass to a trust whilst the testator is still alive, in a Testamentary Trust, the testator remains the outright owner of their assets prior to their death. It is only once the testator has died and executors have completed administration of the estate that legal ownership of the assets is transferred to the trustee of the Testamentary Trust.
The trustee of a Testamentary Trust is not necessarily the same as the executor of the Will. However, they are often the same person or a corporate entity controlled by the executors.
The trustee of a Testamentary Trust is legally obliged to deal with the assets in accordance with the terms of the Testamentary Trust deed.
Benefits of Testamentary Trusts
Flexibility
Flexibility is the most desirable trait of a Testamentary Trust Will. A Testamentary Trust allows for flexibility as to distribution of the income and assets, and also creates flexibility for the investments of the trust.
Usually, Testamentary Trusts are established so as to be valid for many years and accordingly if properly considered and drafted, can benefit several generations of the Testator’s beneficiaries.
Testamentary trusts can give the trustee absolute discretion to distribute income and capital to beneficiaries in the most tax effective manner.
The trustee’s discretion is important where:
- There is significant disparity in the taxable income of the various beneficiaries. Streaming money in a tax effective manner enables optimum allocation of income and capital. The trustee can elect to make larger distributions to lower income earners or to support a beneficiary with a disability. This can change on a yearly basis.
- A beneficiary seeks to qualify for or maintain a youth allowance or an age, disability or sole parent pension. The trustee can make distributions taking into consideration the specific income and asset thresholds of the above allowances.
Income Splitting – Minor Beneficiaries
From a taxation perspective, testamentary trusts allow significant tax savings by enabling streaming to minor beneficiaries.
In an inter vivos trust any income above $416 distributed to an individual under 18 years will be taxed at the top marginal rate. Testamentary trusts have a significant advantage as any income distributed from a trust established from a Will is classified as “excepted trust income”. This enables income distributed to minor beneficiaries to be taxed at normal adult tax rates, with access to the tax-free threshold.
Asset Protection and Family Law Considerations
In a world of multiple marriages and mixed families, individuals may want their separate estate to be placed into a Testamentary Trust. This allows for the familial assets to continue to be for the benefit of their own biological children, rather than to be given to their current spouse who may or may not be the biological parent of their children.
Parents may wish to segregate estate assets to a Testamentary Trust, to exclude their child’s former and current partner(s) from the familial estate assets which may be lost or divided should a claim be made against the child in a subsequent Family Court matter. If the trustee so wishes, the beneficiary may have the benefit of the trust assets in such a way that they do not become property of the relationship.
A testamentary trust may also promote asset protection of the testator’s assets in the following circumstances:
- Where a beneficiary has creditors. Since a beneficiary does not have any claim or ownership of the assets of the testamentary trust, the creditors cannot seize the testator’s assets to satisfy the beneficiary’s debts.
- Where a beneficiary is at a high risk of becoming bankrupt. Unless a distribution is made from the testamentary trust, the testator’s assets will not pass to the trustee in bankruptcy.
Issues to Consider
A testator should seek legal and accounting advice on whether their facts and circumstances warrant establishing a Testamentary Trust.
- Factors which should be carefully considered include:
- Is there a significant pool of assets?
- Can the assets be invested to generate reasonable income per year for the estate?
- Are there beneficiaries who, because of their age or intellectual disability, may be unable to manage money?
- Are there beneficiaries that have a high-risk profile, i.e. divorcing, partner choices, addictions and mental health conditions?
- The ongoing costs and expenses of annual accounting, administrative, regulatory and financial planning fees
Simply, the costs of establishment, ongoing fees and risks to beneficiaries need to be weighed up against all the benefits that a Testamentary Trust Will can provide.
A properly structured Testamentary Trust offers significant control over estate planning, providing flexibility, tax benefits, and asset protection. However, it’s essential to seek professional legal and accounting advice to determine if a Testamentary Trust is the right choice for you and your family.
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For more information on trust structures and to explore the most suitable trust for your needs, visit our dedicated website, All Trust Structures. You can also submit an online enquiry or contact us at 1300 QUINNS (1300 784 667) or +61 2 9223 9166 to schedule an appointment with our tax lawyers.
