What is a testamentary trust?
A testamentary trust is created by a will, which usually commences after the will-maker’s estate has been administered. Although the term “testamentary trust” strictly means any type of trust created by a will, it is commonly used to refer to discretionary testamentary trusts, where the trustee has a wide discretion as to distribute assets and income among a broad range of beneficiaries. Depending on the intent of the will-maker, a testamentary trust may be established to protect vulnerable beneficiaries, or to provide beneficiaries with flexibility to achieve more tax-effective outcomes for their inheritance.
A testamentary trust can be in existence for up to 80 years and can therefore benefit two or three generations with the distribution of the trust’s income and assets being flexible. The assets of a discretionary testamentary trust can be given at any time to the beneficiaries at the discretion of the trustee of the trust.
What are the benefits of a testamentary trust?
A testamentary trust may have tax saving benefits as the income from the assets of the trust can be distributed at the discretion of the trustee to one or more beneficiaries (including minors) at their marginal tax rates.
To place some context around this, a more ‘typical’ will is not likely to provide these tax benefits. For example, in the circumstance of a typical family with parents and children, it is common for a husband to provide in his will that his estate be left to his wife, and for a wife to provide that her estate be left to her husband. It is also common to provide that if a spouse does not survive the other, the estate is to be divided equally amongst their children. This is usually subject to the children reaching a specified age, one at which the will maker considers the children will be capable of maturely managing the assets. While this approach provides simplicity and certainty, it offers no opportunity to minimise tax by distributing income amongst nominated beneficiaries, at the discretion of the principal beneficiary.
Income distributed to an infant beneficiary through a testamentary trust is taxed at normal rates. Thus, according to current tax rules, the first $18,200 of income given to a child through a testamentary trust is tax free to each child, and income in excess of this amount is taxed on the standard sliding scale. This applies to every year of income where a distribution of income to a child through a testamentary trust is made in this way. Within this framework, a trust created by a will can hold assets and distribute the income produced by those assets each year, tax effectively, to beneficiaries including the children or grandchildren of the will-maker. The ability to distribute income to minors in this way is not available with trusts created other than by a will.
Provision for a beneficiary with a disability
Parents of a child with a disability often wish to include a provision in their wills which addresses the future care of their child, whilst at the same time protecting assets for future beneficiaries. A trust for a disabled beneficiary can take different forms – one of which could be a discretionary testamentary trust. Within this context, a reliable trustee is permitted to exercise discretion with regard to the distribution of income and assets in the trust.
Protection of assets
In some cases, a will maker may wish to provide for a beneficiary, but protect the assets allocated to that beneficiary. Circumstances where such a will may be required is where the beneficiary is a spendthrift, may have a difficult matrimonial situation, or may wish to keep assets away from creditors or potential creditors. It should be borne in mind that it is difficult for any trust to offer complete protection of assets against a family law claim.
What to keep in mind
We recommend that you obtain advice from your financial advisor before including a testamentary trust in your will. In particular, you should also consider and seek advice from your financial advisor on the administration costs, capital gains tax, land tax, pension eligibility implications of a testamentary trust.
Further Information and Contact Details
If you would like to discuss any aspects of a testamentary discretionary trust, please contact us on 8251 7777.
This publication is produced by Pigott Stinson. It is intended to provide general information only. The contents of this publication do not constitute legal advice and should not be relied upon as legal advice. Formal legal advice should be sought from us in respect of the matters set out in this publication. Liability limited by a scheme approved under Professional Standards Legislation.