A testamentary trust is technically any trust that arises after you die, based on your Will. It could be a minor’s trust, a life interest, or a more complex trust that could benefit your children throughout their lives.
But when you hear people talk about “testamentary trusts”, they are generally referred to a family discretionary trust that is set up in your Will. I will refer to this type of trust as a Testamentary Discretionary Trust (TDT) for the rest of this article.
A TDT is similar to a family discretionary trust that you might set up whilst you’re alive for the purpose of investing or for running a business. A TDT has a trustee and a list of potential beneficiaries – usually, the primary beneficiaries are your children. The potential beneficiaries are entitled to receive income and/or capital of the trust at the trustee’s discretion, and this could be conditional on your children reaching a particular age.
Like a family discretionary trust, a TDT may also have an appointor and/or a guardian. The power of the appointor is the ability to appoint or remove the trustee to one of the beneficiaries of the trust. This is a crucial role, particularly if you initially chose an independent third party to be the trustee, for example, whilst your children are minors. The power of the appointor could then be given to your children once they reach a particular age so that they then take control of the trust.
The other role is a guardian – it’s the guardian’s function to oversee some of the more significant decisions that a trustee might make. This role would also be important whilst your children are minors, or even if you want to ensure your adult children don’t distribute large amounts of capital to themselves if they have a gambling or other addiction problem.
Benefits of a Testamentary Discretionary Trust
A TDT can protect assets which a beneficiary inherits because they don’t inherit it directly. Instead, it is held in trust for them, and you can determine how much control they have of that trust. This is particularly important if your child or other beneficiary is vulnerable, by being a gambler or having a substance addiction, or even if they have a disability.
A TDT is also useful to protect your beneficiary’s inheritance from bankruptcy, so would be a useful tool if any of your children run their own business and you want to make sure their creditors wouldn’t have access to this inheritance.
Finally, a TDT can also offer some protection from a property settlement if the relationship of your beneficiary and their spouse breaks down. You don’t want your child’s inheritance to be split up to their ex-spouse. This protection is limited, and you will need specific legal advice to achieve the most protection possible.
It is the income splitting capability of a TDT which makes this structure very attractive. Unlike a family discretionary trust which you would set up whilst you’re alive, you have attractive tax advantages under a TDT when paying income to a minor (child under 18 years). This is because a minor beneficiary of a TDT is taxed as an adult, at marginal tax rates – meaning, they are entitled to the tax-free threshold (currently $18,200 tax-free per annum). Compare this is a family discretionary trust, and a minor is only entitled to $416 tax-free and then they are taxed at penalty tax rates.
Below is an example of the ta effectiveness of a Testamentary Discretionary Trust. Tom passes away and has $1,000,000 of personal assets that he leaves in a TDT for his wife Kerry. She is the primary beneficiary, but her two young children are also potential beneficiaries under the TDT, so she can income split income to them from the trust. If Tom didn’t set up a TDT for Kerry in his Will, then she wouldn’t have been able to take advantage of the tax planning and would lose this additional income.
In this example, because Kerry could split the income with her minor children through the trust, she could take advantage of the tax-free threshold and save on tax. This has significantly added to her income throughout the year, so she has more to spend on raising her children.
This article is written by Jacqui Brauman and was first published on the TBA Law website
This article does not constitute legal advice or a legal opinion on any matter discussed and, accordingly, it should not be relied upon. It should not be regarded as a comprehensive statement of the law and practice in this area. If you require any advice or information, please speak to practising lawyer in your jurisdiction. No individual who is a member, partner, shareholder or consultant of, in or to any constituent part of Legally Yours Pty Ltd accepts or assumes responsibility, or has any liability, to any person in respect of this article.