Q & A on Testamentary Trusts

Q. I have heard of some people having Wills that include testamentary trusts. What are they?

A. A testamentary trust is simply a trust that is established through a Will.

There are many different types of trusts that arise in Wills: from a simple trust where funds are held for the benefit of a beneficiary until they reach a specified age; to trusts established for a certain beneficiary for their lifetime; to discretionary trusts, like a family trust, where a trustee holds the income and assets of the trust for a wide range of potential beneficiaries.

Where the rules of a discretionary family trust are usually contained in a trust deed, the rules of a testamentary trust are contained in a Will.

Q. Should I have one?

A. A carefully drafted testamentary trust that includes options with respect to variations of the trust can be very desirable for your intended beneficiaries and are a very powerful estate planning tool. This is the type of Will that you would want your parents to have!

Testamentary trusts allow for:

-asset protection in the event of bankruptcy or marriage breakdown;

-flexibility of tax treatment which can lead to beneficial tax outcomes;

-the ability to protect vulnerable beneficiaries by way of protective trusts.

Q. What are the benefits?

A. The potential for tax savings when income is distributed to benefit a child or grandchild of the primary beneficiary who is under 18 years of age, or to benefit a low income earning spouse is significant.

Unlike a family trust established during your lifetime, where penalty rates apply to unearned income paid to persons under 18 years of age, income distributed to a minor beneficiary from a testamentary trust is assessed to that child at ordinary adult marginal tax rates (including an $18, 200 tax free threshold and low income offsets). This compares favourably to the penalty rates of tax normally applicable to unearned income paid to children under 18 years (where the tax free limit is lowered to $416 and income tax is payable after this at penalty rates of 66% and then 45%, excluding the Medicare levy).

Other Benefits:

There are generally no stamp duties payable when the property of the trust is transferred on your death to the testamentary trust (at its establishment). Nor are there any capital gains taxes payable on the transfer of the property from the deceased’s estate to the testamentary trust or on the transfer of the trust property to an ultimate beneficiary (there are some specific tax issues that exist here which you should be advised on).

Q. Should we “keep it simple” now and add a testamentary trust to our Wills later?

A. The short answer is no. The testamentary trust (or at least the option for the executors, trustees and beneficiaries to create a testamentary trust or not) needs to be included in the Will from the outset. You do not know when you are going to die. Your Will and estate planning should speak from the present and reflect your wishes if you were to die in the near future.

Whilst a testamentary trust will not necessarily benefit you (the price to pay for the testamentary trust’s advantages is your own death) your beneficiaries may, depending upon their circumstances, enjoy substantial benefit as a result of your thorough planning.

As well as discretionary testamentary trusts we often advise on and prepare protective type trusts in circumstances where it may not be desirable that a particular person control their own trust or inheritance due to disability or other issues for example, bankruptcy, addiction, etc.

A Word of Caution

As a testamentary trust only takes effect on your death and deals with your estate assets, it cannot be relied upon to provide you with any level of asset protection during your lifetime. It won’t help you in dealing with your own creditors, nor will it provide you with any level of tax flexibility during your lifetime.  Other structures such as family trusts can help with this.

If you would like to discuss the benefits of a testamentary trust and your estate planning generally, call Donlan Lawyers on (08) 8344 6422.