A testamentary trust is a trust created by a Will. It is generally a discretionary trust – one where the Trustee has full discretion about who benefits, and to what extent, under the trust.
A testamentary trust has two significant advantages for a will maker and the nominated beneficiaries:
- Protection of the bequeathed assets from divorce, financial difficulties or other unforeseen mishaps that the beneficiaries may suffer; and
- Significant taxation advantages in terms of income splitting
Many people are concerned about protecting their assets. They want to make sure that the assets remain within the family and are used to benefit family members.
In particular, people are concerned about:
- their beneficiaries becoming bankrupt, especially those that are involved in highly leveraged businesses;
- their beneficiaries becoming divorced and their assets being split in the divorce;
- spendthrift children;
- ensuring that the surviving spouse will pass on their assets to their children upon that person’s death; or
- looking after handicapped children.
The significant advantage of a testamentary trust is that the assets are owned by one person(s), the trustee, and the benefit of the income and capital of the trust passes to another person/s, the beneficiaries.
This separation of control and benefit allows testamentary trusts to protect assets from any legal action involving the beneficiaries and/or misuse of those assets.
The terms of the testamentary trust are set out in the will. These terms can restrict the ability of any of the beneficiaries to control the activities and investments of the trust or give them complete control.
The Tax Act provides that income and capital gains derived by children under the age of 18 years from assets received as a result of a will are not subject to penalty tax rates. Children who benefit under a will are taxed at the normal marginal rates.
This has the following significant tax advantages:
- Each child has a tax-free threshold of $18,200 and the Taxable income between $18,200 and $37,000 will be taxed at the rate of 19% as opposed to the rates set out in the Table below.
Tax rates for residents who are under 18
Income Tax rates for 2015–16 income year
$0 – $416 Nil $417 – $1,307 Nil plus 68%* (66% plus 2%) of the excess over $416 Over $1,307 47%* (45% plus 2%) of the total amount of income that is not excepted income
- Imputation credits attaching to franked dividends received can be effectively used by the child.
- The main advantage of using a discretionary, testamentary trust for bequeathed assets is that any income gains, capital gains and franked dividends can be distributed among all the family beneficiaries each year in the most tax-efficient way.
- The tax concessions do not apply solely to income and capital gains derived by the trust from inherited assets. They also apply to any income and capital gains derived from assets acquired from the reinvestment of moneys received from the original inherited assets.
- There is no legal limit to how many testamentary trusts a will can establish. Ideally, a will would establish a separate testamentary trust for each beneficiary.
Frequently Asked Questions
Is a Testamentary Trust Different from a Family Trust?
Yes. Although both testamentary and family trusts have similar features, such as the ability of the trustee to decide which beneficiaries of the trust will receive income, there are considerable taxation advantages for infant beneficiaries (those under the age of 18 years) under a testamentary trust. Income received by infant beneficiaries from a family trust will be subject to penalty tax rates should that income exceed $416.00. Under a testamentary trust, infant beneficiaries receive the full tax income threshold of $18,200 tax-free, with income above that amount being taxed at normal adult rates.
Because of the uncertainty as to whether the Federal Government will tax trusts in the future, it is advisable that testamentary trusts be incorporated in a will as an option that can be triggered as circumstances dictate. Even if testamentary trusts are taxed at some future date, there may still be significant tax or other advantages to your beneficiaries if you include a testamentary trust as an option.
If you have a beneficiary who has an intellectual impairment, you could leave part of your estate for that person’s benefit by naming that person as the primary beneficiary (but not a trustee) of a testamentary trust.
This will prevent unscrupulous persons from taking advantage of the beneficiary with an impairment and protect his or her share of your estate. Either a family member, professional adviser or a trustee company could be named as the trustee of this type of testamentary trust.
Who can be Trustee of a Testamentary Trust?
Anyone you wish, including the executors of your will, your spouse or partner, or your children. The trustee has effective control of the trust, so the trustee should be a person who you know, and whom you trust to act in the best interests of those who are to receive the main benefit of either the whole or that part of your estate that will be left subject to the testamentary trust. It is possible to establish a number of testamentary trusts under a will and name different trustees for each of them.
Because testamentary trusts frequently grant trustees full discretion over the bequeathed assets, you should think carefully about whom you appoint as trustee. Although it is common for testators to appoint family members or friends as trustees, this can be awkward if there is a potential conflict of interest. For this reason, some lawyers recommend an impartial trustee.
What if I already have a Family Trust?
The assets of your family trust will not form part of your estate. If all assets are presently owned by your family trust, there would be no point in establishing a testamentary trust unless you planned to wind down your family trust and transfer the assets in it to yourself.
What advice should I obtain before deciding to establish a Testamentary Trust?
You should consult your accountant, solicitor and/or financial adviser, to ensure that you are aware of all the advantages and disadvantages (some of which will undoubtedly depend on your own particular circumstances, both financial and family), before you make your decision.
Alternatively, as stated previously, a testamentary trust can simply be included as an option in your will to cater for future changes in your circumstances or those of your beneficiaries.
If you would like to further information or advice regarding Testamentary Trust and whether it should be included in your Estate plan, please fill in the form below and one of our Specialist Trust and Estate Lawyers will be in contact with you shortly, alternatively you can call us on03 9571 7444.
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