You may have heard of a Testamentary Trust and wondered what it is?

It sounds complicated, doesn’t it? We worked at demystifying the legal jargon around Testamentary Trusts to explain what it is, how you can incorporate it into your Will, and the benefits of a Testamentary Trust.

What is a Will?

Before we talk about Testamentary Trusts, we need to talk about Wills.

A Will is a legal document setting out how you wish to distribute your assets when you pass away. Without a Will, your assets could be distributed in accordance with a statutory formula (the laws of intestacy), which varies from state to state.

Some people have complex affairs and leave property to their loved ones on certain conditions. For example, reaching a certain age. Some wish to minimise the tax ramifications for their loved ones if it is a larger estate.

It is rarely a good idea to leave it to the laws of intestacy to achieve this, and we encourage everyone to draft their Will. The question is then, how complex does my Will have to be? And do I need a Testamentary Trust? 

What is a Testamentary Trust?

A Testamentary Trust is a type of trust drafted into a Will.

The Testamentary Trust only comes into existence upon your death (Trust) for the benefit of your beneficiaries.

A Trustee, who administers your estate, manages the Trust and ensures your wishes are met.

The benefits of a Testamentary Trust are:

  • providing flexibility for asset distribution in your Will;
  • ongoing asset protection for your loved ones; and
  • ongoing tax minimisation.

We look at each of these advantages in turn below.

Benefits of a Testamentary Trust

1. Flexibility

A Testamentary Trust can allow the trustee to distribute the trust’s income or capital to the trust’s beneficiaries in a tax effective manner.

The trust’s trustee can distribute the income each year between the beneficiaries or accumulate it. Accumulating income can, however, result in the beneficiaries paying higher taxes. It is then imperative first to obtain accounting advice.

This means that beneficiaries can choose how and when to take their inheritance, and we discuss the resulting tax benefits below.

2. Asset protection

The Trust owns the Testamentary Trust’s assets, which the Trustee guards.

The Trust, rather the beneficiary, owns the assets. This means that  no one can take the trust’s assets without the Trustee distributing them under the Testamentary Trust’s terms.

This can protect assets and benefit beneficiaries whose assets are at risk from:

  • High-risk occupations – a Testamentary Trust can protect assets from creditors if an individual or corporation sues the beneficiary;
  • Bankruptcy – crisis provisions in a Testamentary Trust can operate to provide that the Trust does not belong to a bankrupt. This means a Trustee in Bankruptcy cannot gain access to an inheritance; and
  • Divorce or relationship breakdown – a Testamentary Trust can help protect assets in a relationship breakdown. However, a word of caution. The High Court in the case of Kennon v Spry looked behind a family trust, as the Family Law Act 1975 (Cth) empowers the Court to do. Although the Court hasn’t examined a Testamentary Trust, it is important that the protected party doesn’t control the trust or hold the appointer (control) positions. Otherwise, the court may hold that the Testamentary Trust is a “sham” to keep the assets away from the other spouse.

Tax Minimisation

Tax minimisation is another benefit of a Testamentary Trust. The Trustee can distribute to the primary beneficiary (for example, a deceased’s son), or between the son and the son’s spouse/young children, if the trust names them as general beneficiaries.

This may help the son’s family split the trust’s income and the family’s tax liability as a whole. Under section 102AG of Income Tax Assessment Act 1997 (as amended), the minor beneficiaries would obtain the full benefit of the special taxation treatment of their income. Such funds could then be used to pay for school fees or other items.

After Death – the Ongoing Trust

A Testamentary Trust’s assets are not limited to the deceased estate’s assets.

The trust lasts 80 years following a person’s death whose Will created the Testamentary Trust. It can acquire other assets that generate extra income streams to the Testamentary Trust. The beneficiary, their children and potentially great grandchildren of the deceased person can use this income, which can also be subject to the same favourable taxation treatment when distributed to minor beneficiaries.

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If you wish to discuss Testamentary Trusts or prepare a Will incorporating a Testamentary Trust, give our Client Care team a call today to discuss on 1300 544 755.

Emma Heuston

Next Steps

If you would like further information on any of the topics mentioned in this article, please get in touch using the form on this page.