When making decisions about your estate for after you pass away, you have probably considered and undertaken the drafting of your will. Wills are an effective way to ensure that your assets are distributed to your family and friends according to your wishes. However, including a testamentary trust within your will may increase your control over the distribution of your estate to friends and family. This article will explain what a testamentary trust is and go through four advantages that they could have for your future.
What is a Testamentary Trust?
A testamentary trust (also referred to as a will trust) offers greater control over estate planning and distribution to beneficiaries compared to simple wills.
A testamentary trust is as a trust established by a will, the benefits being:
- maximum flexibility;
- better asset protection from third parties; and
- tax planning advantages.
Most testamentary trusts nominate a primary beneficiary (such as an adult child) and then allow for secondary beneficiaries. These may be the spouses of your children, grandchildren, etc.
Commonly, a beneficiary is the surviving spouse or child of a deceased party. It is possible to have multiple testamentary trusts in a will – one for each primary beneficiary.
There are four main advantages to testamentary trusts.
1. Flexibility
Testamentary trusts allow for greater flexibility to suit your particular circumstances.
As a testamentary trust functions similarly to a discretionary family trust. Accordingly, the trustee may decide which beneficiaries receive trust income, provided that they are nominated in the trust.
This flexibility means that the trustee can make tax efficient choices when distributing any:
- income;
- capital gains; and
- dividends.
Additionally, trustees will have the maximum flexibility to deal with superannuation benefits, in the case that they are paid to the estate.
2. Estate Planning
Compared to a simple will, a testamentary trust allows beneficiaries to take more control over assets against third parties.
As the trustee holds the title to the trust’s assets (rather than the beneficiaries directly), this allows testamentary trusts to protect assets from any potential:
- court proceedings;
- bankruptcy; or
- legal action.
If your surviving spouse or an adult child is engaged in business with a significant financial risk, a testamentary trust can provide more asset protection. Similarly, it may provide family law protection for adult children.
3. Tax Planning
Testamentary trusts allow trustees to distribute and split the income of the trust with tax planning in mind.
Moreover, distributions from a testamentary trust to minors will receive the usual full tax-free threshold concessions, currently at $18,200 (as of Janurary 2019). This tax planning benefit is considerable to beneficiaries who have children under 18 as they can pay for their children’s expenses out of pre-tax income. This is useful for things such as school fees or other extra-curricular expenses.
4. Capital Gains Tax Benefits
When a capital gains tax asset passes from the executor (the person appointed to carry out the will) to a beneficiary, the law will disregard any capital gain made by the executor. The ATO views the trustee of a testamentary trust in the same way as a legal personal representative of the estate (for example, the executor).
Moreover, there is no tax on the transfer of cash proceeds of a life insurance policy or superannuation death payout. However, you should contact your accountant to discuss your particular circumstances.
Testamentary Trust Considerations
There are a number of particulars that you should consider before setting up a testamentary trust.
Firstly, similarly to a will, a testamentary trust does not come into effect until after your death. While it is possible to set one up after you die, your beneficiaries must do so within three years of your death. The beneficiaries of a post-death testamentary trust will be limited to your spouse and children. You can only fund the trust with your assets, as well as payments made in consequence of your death (including superannuation and insurance proceeds).
It is important to note that you must draft testamentary trusts with the will maker’s personal circumstances in mind. Moreover, there are ongoing costs involved in maintaining a testamentary trust such as tax returns for the trust.
Key Takeaways
Whether you should include a testamentary trust in your will depends on your particular circumstances and needs. Testamentary trusts can be a useful instrument for effective estate planning. They can be particularly useful where beneficiaries:
- have potential risk issues;
- are children under 18; or
- would like to protect assets from claims by spouses or partners of your children.
We appreciate your feedback – your submission has been successfully received.
