A Testamentary Trust is a discretionary trust forming part of a Will, which bears a resemblance to a normal Discretionary Family Trust which you might put in place during your lifetime. The key difference is that a Testamentary Discretionary Trust does not come into effect until after the death of the Will maker.
Why would I want a Testamentary Trust Will?
There are a number of benefits to a Testamentary Trust Will which are not available in a Standard Will.
Some of these include:
Asset Protection – you do not want assets available to the creditors of your beneficiaries or available to their spouses in the event of relationship breakdown.
Advantageous Tax Treatment – your beneficiaries can allocated trust income to a range of beneficiaries, and unlike ordinary trusts minors can take advantage of the tax free threshold and concessional rates.
Flexibility – you can avoid giving lump sums to young adults, spendthrifts, and incapacitated beneficiaries, who you may not trust to spend their inheritance wisely.
Asset Protection
The assets in a Testamentary Discretionary Trust are controlled and managed by the trustee, rather than individual beneficiaries. Beneficiaries of a Testamentary Trust have no absolute right to any assets in the trust (unless you opt to give them this). In other words, they do not legally own the assets of the Trust. They simply have a right to be considered when the trustee decides to make a distribution.
As the beneficiaries have no fixed entitlement in the trust, the assets of the trust are considered separate from their personal assets. A properly structured Testamentary Trust can protect your beneficiaries’ inheritance in the following situations:
Bankruptcy
A Testamentary Trust can offer protection from the trustee in bankruptcy in the event that a beneficiary is made bankrupt. This is because the trust assets are not actually owned by the beneficiary, so they are not available to creditors.
Marriage breakdown
A Testamentary Trust can assist in protecting your beneficiary’s inheritance upon a marriage breakdown.
However, the Family Court has broad powers when determining whether assets held in the trust can be included in the matrimonial pool of assets, so it is essential to take care in the drafting of any Testamentary Trust in order to safeguard an inheritance.
Advantageous tax treatment
With a standard Will, your beneficiaries receive their inheritance directly in their personal name. Although this means that they can decide how their inheritance is invested or used, they will be assessed for income tax on any income generated from the inheritance at their own Marginal Tax Rate. If you have a beneficiary with above average income, it is likely that the beneficiary may need to pay tax on the income earned from their inheritance at higher rates which could potentially be 47% on the dollar.
If you have a Testamentary Trust Will and the assets in the trust generate income, the trustee has the discretion to decide how that income is distributed amongst the beneficiaries. When income is distributed to beneficiaries, beneficiaries will pay tax on that income distribution at their own marginal tax rate. The trustee may determine to distribute income appropriately in order to reduce the overall amount of tax paid.
Testamentary Trusts benefit from special rules which allow minor beneficiaries of a trust to receive the full adult tax free threshold each year. This means that infant children can receive distributions of income up to the tax-free threshold (approx. $18,200) before they are liable to pay tax. By comparison, a distribution to a minor child from a normal family discretionary trust established during a person’s lifetime are taxed at the highest tax rate of 47% on any distribution over $416.
For example, if you have two properties in the trust receiving rental income of $100,000 per year and you have 6 minor grandchildren. You could “distribute” the rental income equally to each of the grandchildren (approx. $16,670.00) each year and pay no tax. However, if the properties had been gifted to your children’s personally, the rental income would be added to their personal annual income and likely to be heavily taxed. For the record, the grandchildren do not actually have to receive the income allocated to them each year.
Flexibility
You may not trust a beneficiary to use his or her inheritance wisely for example, if they have a gambling problem or a drug addiction, or you want to ensure your minor beneficiary do not receive their whole inheritance immediately after they turn 18 or 21. A testamentary trust Will can financially protect a minor beneficiary, a vulnerable beneficiary and a spendthrift beneficiary.
As testamentary trusts can be customised to suit your individual needs and circumstances, you can decide:
Who the trustee will be, and the alternative trustee/s if the trustee loses capacity or passes away;
What trustee can or can’t do;
Who the appointor (person with the power to appoint and remove trustees) will be, and the alternative appointor if the appointor loses capacity or passes away;
Who the beneficiaries of the trust will be (this can include children, grandchildren, spouses, nieces/nephews etc and other trusts);
Who receives the capital of the trust;
Who receives the income of the trust;
When and how beneficiaries can receive distributions from the trust; and more.
If you have any questions in relation to any of the information mentioned above or you would like to speak with one of the solicitors in our award-winning estate planning team regarding your personal circumstances, please do not hesitate to contact us.
Article by Connie Ung.
E: ConnieUng@robbinswatson.com.au
P: (07) 5576 9999
Connie is a solicitor practising predominantly estate planning and deceased estate administration, at Robbins Watson Solicitors. See her full profile here:
https://robbinswatson.com.au/our-people/connie-ung