What is a testamentary trust?

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A testamentary trust is simply a trust created in a Will.

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These trusts can take many forms, but typically refer to discretionary trusts where a trustee has the power to decide who receives what from the trust assets. 

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Usually an inheritance is gifted into the trust for the benefit of a beneficiary (e.g. child), instead of that inheritance going to the beneficiary personally.

 

What's the difference between a non-trust will and a testamentary trust?

 

A beneficiary normally receives their inheritance directly and the asset or funds becomes their property in their

 

If that person is sued, or suffers a relationship breakdown, then the inheritance is not separated from their personal assets. This can mean that an inheritance which was meant to provide for the beneficiary for many years is lost to potential predators or creditors.

 

Why use a testamentary trust?

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The two main advantages are asset protection and tax minimisation: 

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Income tax advantages

 

A testamentary trust allows a beneficiary to split the income from the inheritance between themselves and their children, and each person and child can take advantage of their marginal taxation rates and the tax free threshold (approximately $22,000 a year tax free for minors).

 

Example

Mrs Campbell earns $100,000 a year in income. She then inherits $900,000 from her mother. She invests it in term deposits within a testamentary trust paying an average rate of interest of 5% giving the testamentary trust income of $45,000 per annum. She distributes the income to her 3 children who are under 18 for their school fees etc. The tax implication of this is as follows:

 

Child 1

Income              $15,000

Tax paid             $0

Income              $15,000

 

Child 2

Income               $15,000

Tax paid              $0

Income               $15,000

 

Child 3

Income               $15,000

Tax paid              $0

Income               $15,000

 

After tax             $45,000

 

If Mrs Campbell inherited it personally and invested the $900,000 in the same term deposit with interest of 5%, she would pay:

 

Mrs Smith

Income                                    $45,000

Tax paid (assuming 37%

marginal tax rate due

to other income earned)        $16,650

 

After tax                                $28,350

 

Note: funds cannot be invested in children's names as the income will be caught under the penalty rates of tax imposed on minors.

 

Bankruptcy protection

 

Assets of a properly drafted testamentary trust are not ordinarily available to the creditors of a bankrupt beneficiary. Therefore you can have peace of mind in providing any inheritance to a child or spouse who may be at risk of bankruptcy, and not be concerned that their inheritance will end up with their creditors. You may not think a child is a 'problem' child who is at risk, but if they are a professional in a high risk profession, such as a doctor or lawyer, they are at risk of litigation because of their profession.

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Vulnerable Beneficiaries

 

By separating control of the inheritance from its use you can protect vulnerable beneficiaries from the influence of others, or gambling problems, drug addiction, or a propensity to waste money.

 

This is because the Will-maker can nominate a trusted person to be trustee of the inheritance on behalf of the beneficiary, and allow the trustee to supervise or control the access to the inheritance.

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Relationship Breakdown

 

Assets held in a discretionary testamentary trust are not the assets of any one individual.  The inheritance assets can be clearly separated from the assets of your child’s marriage, and that separation maintained if the child separates from their spouse.  This separation will assist your child in coming to a property settlement with their former spouse and identifying their respective contributions to relationship property.  The inheritance may be considered as a resource of one of the children in a family law dispute, and in extreme examples, may be considered part of the relationship property, depending upon how it is treated.

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Blended Families

 

A balancing act is required in blended families to provide for a surviving spouse, whilst ensuring that children ultimately receive an inheritance. When we remarry later in life, and we have children separate from our spouse, we may want to use a structure which allows us to secure our children’s inheritance from us, whilst still providing for our spouse.  This might include for example, income from an investment portfolio, or a right to reside in the family home for life.  Testamentary trusts can be tailored to meet any needs. 

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Special Disability Trusts

 

Special disability trusts are trusts designed to hold assets, particularly a main residence, for a person with a disability.  The advantage to them is that the assets (up to a threshold) are not counted in the means testing for that person’s disability pension.  They are also entitled to the main residence capital gains tax exemption.  SDTs are individually approved and must be drawn to the requirements of Centrelink.  An SDT can be established now, or in your will.  

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