Do I need a testamentary trust?
Trusts can be established for either personal or business purposes with the intent that the trustee will hold certain assets, including property, for the benefit of the beneficiary (the person set up to receive such assets). There are many different types of trusts available. In this article, we will explore what testamentary trusts are for the purposes of distributing assets in a Will, along with the associated benefits and tax obligations of setting up this type of trust.
Estate and succession planning can be a crucial consideration at varying stages of your life as it plays an important role when you are starting a family, a business or where your personal, family or financial circumstances change.
As you start thinking about protecting your wealth and providing for the ones you most care about, you should consider how to maximise the beneficiaries of your estate by protecting their future assets and managing their potential tax obligations.
Proper and careful estate planning can help reduce capital gains tax, stamp duty and other taxes that may arise upon distribution of your estate to your beneficiaries and also protect your assets from creditors, predators and the like.
One of the most powerful modern estate planning strategies is the use of a testamentary trust in your Will.
What is a testamentary trust?
Simply put, a testamentary trust is a trust created under a Will with the objective that the trustee (often, the executor of the Will) will hold and manage the will-maker’s assets (estate) to be distributed, in the form of income or capital, to the beneficiaries according to their Will. This, of course, does not come into effect until after their death.
Testamentary trusts provide many benefits including greater asset protection, income tax benefits, superannuation and life insurance interest.
There are different types of testamentary trusts that can be established and each primary/principal beneficiary under your Will can have a testamentary trust that is most suitable to the circumstances of that particular beneficiary.
Some common types of testamentary trusts established under a Will are as follows:
- Beneficiary controlled testamentary trust
As the name suggests, the beneficiary of a beneficiary controlled testamentary trust is provided with an option to use a discretionary trust structure that he or she controls to receive his or her inheritance. This structure is commonly used as a substitute for an outright gift by making use of a discretionary trust structure to enhance asset protection and tax liability.
- Capital reserved testamentary trust
Under this structure, executors control the trust as opposed to the beneficiary and is commonly used to protect the capital assets in the estate (such as the family home) for an intended beneficiary who is vulnerable because of age or capacity.
- Protective testamentary trust
Protective trusts are commonly established for vulnerable family members (such as beneficiaries suffering from a disability), and can be an ‘all needs protective trust’ and/or a ‘special disability trust’ depending on the specific requirements and circumstances of the vulnerable beneficiary.
Key benefits of testamentary trusts
One of the key benefits of a testamentary trust structure as opposed to an outright gift under your Will is that it offers the beneficiaries the opportunity to allocate (or split) the income they receive from the inherited assets amongst the wide range of beneficiaries such as their spouse, children, relatives and charities. This allows the beneficiary to manage his or her tax affairs effectively amongst the family members and related entities.
Another advantage of using a testamentary trust is that minor beneficiaries are taxed in their own hands as adult marginal tax rates unlike an inter vivos discretionary trust, where such distributions are considered ‘unearned income’ for minors and distributions above a nominal reduced tax-free threshold are taxed at penalty rates.
Inheritance held in testamentary trusts are considered ‘trust assets’ and as such provides certain asset protection to the beneficiaries, in particular, assets held in the testamentary trusts are protected from assets being lost through bankruptcy of the beneficiary. Testamentary trusts also offer an enhanced, but not absolute, level of family law asset protection for a primary beneficiary. While a testamentary trust will normally be considered a resource of the primary beneficiary for family law purposes, it is rare for an Australian Family Court to order the division of a testamentary trust between the parties to a domestic relationship.
When should a testamentary trust be used?
A testamentary trust is best used where the testator wants to create a structure which will give each member of the family an option of entering into a trust structure, which can provide the beneficiaries a means to reduce the impact of tax, and to gain asset protection specific to their circumstances.
A testamentary trust may not the best strategy if there are no family interests to protect, for instance where the whole estate is to go to a charity.
Get expert advice
Testamentary trusts, when properly implemented, can provide many benefits from protecting family wealth to minimising tax implications. However, it is important to get expert legal advice from an experienced wills and estates lawyer if you are looking to set up a trust to ensure it is executed and managed correctly, and complies with Trust Law.
To help you better understand how testamentary trusts are set up and whether it is the right type of trust for your individual circumstances, we have prepared an Introductory Guide to Testamentary Trusts.
For more information and expert advice, ask to speak to one of our Estate Lawyers at Ezra Legal on (08) 8231 6100 or email admin@ezralegal.com.au
For other succession-planning insights, head to:
- Succession Bill Update
- Binding Death Benefits
- Things to think about before your wills appointment
- Free Introductory Guide to Estate Planning
Julian Roffe
Practice Manager
Ezra Legal
