What is a Testamentary Trust Will?

A Testamentary Trust Will is simply a Will that creates a trust. Whilst it can be either a fixed or a discretionary trust usually reference to a Testamentary Trust Will is to a discretionary trust (also known as a family trust).  These trusts commence at the time of the will maker’s death and are funded by the assets of the deceased’s estate and administered by a trustee nominated by the will maker.

A discretionary (or family) trust is a trust where the trustee has the discretion to distribute income and/or capital to the beneficiaries of the trust.  The beneficiaries are usually broad and usually include relatives of the trustee. These beneficiaries have the “right to be considered” by the trustee when making distributions.

Why make a Testamentary Trust Will?

There are three main reasons for establishing a Testamentary Trust Will:

1. Control

As it is the trustee of the testamentary trust who has the discretion as to who benefits from payments of trust income and capital it is usual that the main beneficiary who controls his or her own testamentary trust and that he or she be appointed the trustee and appointor (ultimate controller) of the trust.  However, it may be that the main beneficiary needs someone else to monitor their spending and use of their inheritance, or protect it from ‘predators’ or creditors, and if so, it may be useful to appoint another person as trustee or co-trustee or even include a clause so that the main beneficiary becomes a trustee and appointor of his or her testamentary trust upon reaching a certain age.

2. Asset Protection

Being a discretionary trust, a testamentary trust provides beneficiaries with asset protection because the beneficiaries themselves do not own the assets.  The beneficiaries merely have a right to be considered by the trustee to benefit from distribution of trust income or capital.

It can often be useful to quarantine a beneficiary’s inheritance from other matrimonial assets. However, the Family Court might still take into account the value of the assets held in a testamentary trust when assessing a property split and maintenance payments.  The level of control a beneficiary has over the testamentary trust is important in this regard.  A detailed discussion of this point is beyond the scope of this article, but we would be happy to discuss this further if necessary.

The ability to quarantine an inheritance can also apply where assets are gifted to individuals who are at risk of claims from creditors.

3. Tax Advantages

 Income splitting. Being a discretionary trust the trustee has discretion as to whom to pay the income or capital of the trust.  So the trustee can distribute trust income amongst the main beneficiary’s family members and take advantage of any member who has a lower income and therefore is subject to a lower marginal tax rate.

Ability to distribute income to minor beneficiaries at adult tax rates. Unlike discretionary trusts established by people during their lifetime (“inter vivos trusts”), a minor beneficiary in receipt of trust income from a testamentary trust is subject to normal adult tax rates.  Therefore, up to approximately $18,200 can be paid to and applied for the benefit of each minor, tax free.  With the low income rebate this amount may be higher.  By contrast income paid to and applied for the benefit of a minor from an inter vivos trust is subject to the highest tax rate (currently 48.5%).

Accordingly money for minors’ education and advancement can be distributed to the minors to take advantage of these low tax rates.

Taxation of Undistributed income.  There may be tax benefits in relation to undistributed income.

Why not make a Testamentary Trust Will?

1. Costs and Administration

Each testamentary trust needs to lodge a separate tax return. This of course means extra ongoing administrative and accountancy costs for the beneficiaries down the track.

2. Non-Estate Assets

Often the complexities of having testamentary trusts may not be worthwhile as the testator’s estate may not have sufficient assets.  A Will can only deal with the testator’s estate, that is assets owned (as distinct from controlled) by the testator. Jointly owned assets, superannuation benefits, and assets in other entities such as private companies and inter vivos trusts do not form part of a testator’s estate, except to the extent that shares in such companies or units in such trusts are owned by the testator.

3. Family Trust Elections

In relation to discretionary testamentary trusts, in order to carry forward revenue losses to offset against income in later years it will generally be necessary to make a family trust election.  Such elections are also required to allow franking credits on dividends on shares to flow through the trust. A detailed discussion of this point is beyond the scope of this article, but we would be happy to discuss it further.

4. Capital Gains Tax

Where the main residence is held by a trust a loss in the main residence capital gains tax exemption would result.  Accordingly it is advisable to ensure that the testamentary trust provides the flexibility to enable ownership of the residence to pass to the primary beneficiary personally if the primary beneficiary is going to live in the residence and therefore claim the main residence exemption.

5. Land tax

Where land is held in a trust it will be subject to a higher rate of land tax.

In summary there are potentially significant tax and other advantages for beneficiaries if testators create discretionary testamentary trusts.

For more information please contact our friendly and professional team at Peter Speakman & Co on 9822 8611.