A Testamentary Trust is a trust established pursuant to a will which comes into effect after the will-maker dies. Instead of passing the assets directly to individual beneficiaries, the Executor places the assets into a Testamentary Discretionary Trust.
There are several advantages to a Testamentary Trust Will which are not available under a Standard Will, such as asset protection, advantageous tax treatment and flexibility. This article focuses on Advantageous tax treatment. You can read my previous article on the Testamentary Trust structure generally and its benefit: What is a Testamentary Trust, and should you have one?
Overview of Testamentary Trust Tax Benefits
Firstly, a Testamentary Trust provides an important tax advantage because it allows the trustee to split income generated from the Testamentary Trust among the trust’s discretionary beneficiaries in a way that reduces the overall tax paid on the trust’s income.
Additionally, the trustee exercises discretion to decide which beneficiaries receive trust income. The trustee then allocates trust income to those selected beneficiaries. The beneficiaries subsequently include that income in their personal assessable income, which their own marginal tax rate taxes. As a result, the trustee can maximise the net trust income by streaming income to beneficiaries with lower marginal tax rates such as minors, students and spouses who do not work or have lower incomes.
Furthermore, Testamentary Trusts benefit from special rules called “Exempt Trust Income”. These rules allow minor beneficiaries of a trust to receive the full adult tax-free threshold each year. This means that minor children are taxed at individual rates (about $18,200 tax-free and the balance at normal adult rates). In contrast, a distribution from an ordinary Family Trust (not forming part of your will) to a minor attracts penalty tax rates.
To illustrate this further, see the table below:
The current resident minors tax rates: Family Trust VS Testamentary Trust
| Distribution | Family Trust | Testamentary Trust |
| $0 to $416 | NIL | NIL |
| $417 to $1,307 | 66% | NIL |
| $1,307 to $18,200 | 45% of the entire amount of eligible income | NIL |
| $18,201 to $45,000 | 45% of the entire amount of eligible income | 19% |
| $45,001 to $120,000 | 45% of the entire amount of eligible income | 32.5% |
| $120,001 to $180,000 | 45% of the entire amount of eligible income | 37% |
| $180,001 and over | 45% of the entire amount of eligible income | 45% |
Case Study 1 – Income Streaming Example
- Matthew’s wife passed away many years ago.
- Matthew only has one adult child, Jane. Jane has 3 minor children.
- Jane is a pharmacist and earns $130,000 per annum.
- Matthew’s only significant asset is his family home, which is a contemporary 3-bedroom house worth approx. $1,500,000.
- Matthew decides to leave everything to Jane.
- Jane owns a 3-bedroom townhouse.
- After Matthew passes away, Jane receives the house and, in turn, rents it out as an investment property, which generates approx. $50,000 p.a. in rental income.
Standard Will – Without a Testamentary Trust
Under a Standard Simple Will, Matthew’s house is transferred to Jane individually as the sole beneficiary. As a result, Jane combines the $50,000 rental income with her $130,000 salary. Therefore, her total income falls into the $120,001 to $180,000 tax bracket, which attracts a 37% tax rate. Consequently, she pays $18,500 in tax on the rental income and is left with $31,500 after tax.
Testamentary Trust Will
However, under a Testamentary Trust Will, Matthew’s Will creates a Testamentary Trust which Jane controls as trustee. The trustee transfers the property into the Testamentary Trust, which continues to generate the same $50,000 return.
Additionally, Jane streams the $50,000 rental income to her three minor children and splits it equally between them (i.e. $16,667 each). As a result, the children pay no tax because each distribution falls below the tax-free threshold.
Therefore, this case study shows that Jane saves $18,500 in the first year by using a Testamentary Trust.
Furthermore, over a 7-year period (excluding compounding), Jane saves a total of $129,500 in unnecessary tax, as demonstrated in the table below.
Capital Gains Tax Considerations
In addition, capital gains received from assets held in a Testamentary Trust can also be streamed to beneficiaries, which further reduces tax exposure.
For example, if Jane holds Matthew’s house for 8 years and then sells it for $1.7M, the sale results in a $200,000 capital gain.
In contrast, under a Standard Simple Will, the $50k rental income plus the $100k capital gain (after the 50% CGT discount) is added to Jane’s taxable income, bringing her total income to $280,000 and pushing her into the top marginal tax rate of 45%.
However, under a Testamentary Trust Will, Jane streams the $150k income to her three minor children, who split it equally. Each child therefore pays only $6,717 in tax.
As a result, in the eighth year, Jane saves a further $43,349 through the Testamentary Trust structure.
Important Disclaimer
Please note the above examples are for illustrative purposes only and all estate planning solutions need to be tailored to your personal circumstances. If you would like to speak with one of the solicitors in our award-winning estate planning team, please do not hesitate to contact us.
