Testamentary Trust vs Discretionary Trust – which is right for you?

Trusts exist to help ensure your estate ends up with those you want to receive the benefit of your acquired assets – be it cash or property.

There are two types of trust – testamentary trusts, which are triggered by your death, and discretionary family trusts, where a trustee holds the property and allows the accumulation and distribution of assets while you are still alive.

Each type of trust has advantages and disadvantages. This is why it’s best to obtain expert legal advice to ensure a trust suits your particular needs before embarking on the process of setting it up.

What is a testamentary trust?

A testamentary trust is incorporated in a will to provide a greater level of control over the distribution of assets to beneficiaries.

Instead of assets being left to a beneficiary, they are transferred and kept in a trust on behalf of its beneficiaries. This can provide tax advantages and asset protection benefits.

Pros and cons of a testamentary trust

A testamentary trust can protect your children and grandchildren, ensuring they are cared for out of your estate. For instance, if your child has a marriage breakdown, the trust funds are protected from money-grabbing in-laws. Similarly, the assets are protected if your beneficiary becomes bankrupt.

Testamentary trusts can also be beneficial if you want to ensure protection in the long term if the intended beneficiary has dependency issues (eg drugs or alcohol) or is intellectually disabled.

The biggest advantage of a testamentary trust is that it allows you to maintain some sort of control over what happens to your assets after you die. However, there is a disadvantage – you have to die for the trust to be triggered.

Tax benefits of creating a testamentary trust

Testamentary trusts can provide significant tax minimisation benefits for large estates. You can split income from a capital trust fund between other people, including children, where such people often do not pay tax on an income less than $18,000.

For instance, if a beneficiary receives $2 million in a testamentary trust and it accrues $100,000 income each year, the beneficiary could pay tax at 50 per cent on that income (depending on their salary), as the beneficiary would have to add that amount to their taxable income.

However, if they give $18,000 to their spouse, two children, and three unemployed nieces and nephews, then there is potentially no tax payable on any of the $100,000 trust income, saving $50,000 in tax.

What is a discretionary trust?

A discretionary family trust is a legal entity under a trust deed that is able to own assets and invest money. Each year, the trustee decides which beneficiaries are entitled to receive income and how much they should get.

A common structure used by families to run their business, a discretionary trust can provide tax minimisation benefits. However, it is important to know that minors receiving money under a discretionary family trust are taxed at about 50% for every dollar they receive.

Seek advice before setting up a trust

It is very important to set up your trust properly according to law, attending to every detail carefully and wording it in such a way as to ensure there are no traps or pitfalls. It is also vital to appoint the right person to act as trustee.

For more information and expert advice, ask to speak to Wills and Estates lawyer at Ezra Legal Tom Sheridan on (08) 8231 6100 or email tsheridan@ezralegal.com.au

For information on the range of commercial legal services that we provide at Ezra Legal, head to:

• Services – Wills and Estates – Ezra Legal
• Tom Sheridan – Wills and Estates – Ezra Legal
• Ebook – Introductory Guide to Testamentary Trusts

Julian Roffe

Practice Manager

Ezra Legal