What is a Testamentary Trust?

What are Testamentary Trust Wills?

A Testamentary Trust is simply the name for a trust that is created by a Will.

Where discretionary or family trusts are normally created by a separate trust deed, during a person's life, testamentary trusts are written into the terms of the Will, and only come into effect on the Willmaker's death. In this way, assets held in the trust are only distributed as a part of the deceased estate.

Are testamentary trusts relevant to the 21st century?

Yes! In fact, estate planning and incorporating Testamentary Trusts into Wills has never been more important or relevant. Australia is anticipated to experience the greatest intergenerational wealth transfer in history within the next 20-30 years- with the ‘baby boomer' generation expected to pass on over $3.5 billion in assets, by way of inheritances.

That’s a lot of wealth, a lot of opportunity and a lot of testamentary trust potential to pass onto next generations.

Specific features of testamentary trusts?

While Testamentary Trusts operate in the same way as other types of trusts, they offer their own unique form of asset protection on wealth within a family.

Testamentary Trusts share the common feature of all trusts – a separation between the Trustee (as the legal controller of the Trust) and the beneficiary (as the party who is entitled to the income of the Trust). As such, they can provide significant asset protection to any at-risk primary beneficiary.

More importantly, and uniquely, Testamentary Trusts can provide a simple way to split tax liability on inherited income and the deceased's assets to family members.

Who should use a Testamentary Trust?

If you're serious about estate planning and your family situation falls into one of the categories discussed below, it is worth considering including a Testamentary Trust in your Will as a unique, effective and more tax effective method to protect trust assets in the short term, and family wealth in the long term.

Testamentary Trust Wills should be considered as a protection and risk management tool for estates involving potentially valuable assets or high value inheritance. Regardless of a person's assets, they can be a useful legal arrangement in a wide variety of other circumstances.

Testamentary Trust Will vs Standard Will?

Ordinarily, in a standard Will, beneficiaries receive their inheritance in a personal capacity- meaning such assets are transferred directly into the personal name of the beneficiaries. Any assets owned in a personal capacity are exposed to risk, as these can be called in to pay off debts, as well as tax obligations.

With a Testamentary Trust Will, the beneficiary does not inherit anything from the estate in a personal capacity. Instead, their inheritance passes into the Testamentary Trust, and the inheritance held in the Trust is then managed by the Trustee. Trust capital is then distributed according to the terms of the trust, as well as at the discretion of the trustee in a discretionary trust.

Benefits of a Will with a Testamentary Trust:

• Asset protection, where inherited assets or funds may otherwise have been able to be recovered or seized by creditors of the beneficiary during bankruptcy proceedings

• Some protection from the effects of family law proceedings, where inherited assets are often counted as assets of the marriage and can potentially be claimed by an ex-spouse or partner

• Protection from claims on the assets of family members who are involved in a high-risk profession where they might be sued

• Protection for beneficiaries who can't wisely manage an inheritance because they're too young, or have a history of substance abuse, gambling, or inappropriately spending funds

• Protection for beneficiaries who are unable to manage their own legal or financial affairs due to a physical or mental disability

Income tax benefits of a Testamentary Trust

When it comes to taxation, setting up a Will with a Testamentary Trust can have significant advantages for both the Will maker and the beneficiaries of the trust assets.

In allowing the Trustee to assign income to different beneficiaries, the Trust can take advantage of their different tax rates to increase the value each beneficiary receives from the trust assets.

Children & testamentary trusts in Australia

In particular, minor children who are beneficiaries of a Testamentary Trust are not required to pay tax at the penalty rates they are normally subject to on income.

Instead, children receive the adult tax-free threshold for income generated by a Testamentary Trust (which, at time of writing, is $18,200 per financial year). This tax advantage is exclusive to Testamentary Trust Wills and is not afforded to income generated by other types of Trusts, such as Family Trusts.

What does this mean for you? Put simply, it locks in lower tax rates for your beneficiaries. And if that wasn’t good news enough, a testamentary trust also increases security; given that trust assets are protected from creditors.

That’s more support, more safeguarding and more financial security just when it matters most.

These tax advantages are especially relevant when these benefits can be transferred into boarding school fees, education or other care-related costs.

Other valuable assets can also be protected from income tax in this way, when assets are held in multiple testamentary trusts to different beneficiaries.

Testamentary Trust disadvantages?

When deciding whether a Testamentary Trust is right for you, it's worthwhile weighing up the benefits, and seeking professional advice before moving forwards.

Whilst there are income tax benefits, there are also disadvantages of having a Testamentary Trust.

Limited control

Firstly, given the discretionary power of the Trustee, you have limited control of how trust assets are distributed, unless you specify conditions or instructions in your Will.

With this in mind, it is important to choose a Trustee that you are confident will have your beneficiaries' best interests in mind.

Cost of a Testamentary Trust Will in Australia

A Will with a testamentary trust also requires some extra effort and cost up front.

After the death of the testator, there is also ongoing estate administration in the form of applying for a tax file number and lodging a tax return each year- which can create added work for the executor (if they are assigned as the trustee).

Post-death, these ongoing costs, such as Accountant fees for preparing and lodging Trust tax returns, can be especially high if the person you appoint as the Trustee is an independent professional. It is common for income generated by the Trust to be used to pay these fees, provided there is sufficient income to do so. When built up over time, the costs of a testamentary trust can eat into the income beneficiaries receive.

How to set up a Testamentary Trust Will in Australia

Testamentary Trusts must be established during the estate planning process and written into the testator's Will.

Pre-death:

1. Identify the assets

To set up a Testamentary Trust you must first establish what assets will pass to the Trust. You should create an inventory of the value of all assets held- including property, cash, income derived from business and shares.

You can then decide if all your assets are to pass into the Trust, or if you want to include or exclude certain assets from the Trust. You can create multiple testamentary trusts, each with a different primary beneficiary. Or, you can place family assets in a different trust, depending on the beneficiaries you intend to pass assets onto.

2. Nominate a Trustee and/or Controller

Next you will need to choose a Trustee to manage the Trust when you die. This should be someone you can rely on to manage the Trust on a long-term basis and act in your beneficiary's best interests.

Most people will appoint their spouse, an adult child, or another close family member or friend as Trustee of the Testamentary Trust. However, some of the advantages of a Testamentary Trust can be reduced if the Trustee and beneficiary of the Trust are the same person. It is recommended that you speak with an estate planning lawyer to discuss who the best Trustee for your Testamentary trust might be. In some cases, your trustee might be the executor of your will.

3. Name your beneficiaries

Identify the people or groups who will be the beneficiaries of the Testamentary Trust. This can be a spouse, children, other family members, close friends, or even an organisation.

A Testamentary Trust, once it has come into effect post-death, can exist for up to 80 years (depending on what state you are in). It is therefore important to consider who the beneficiaries of the Trust will be after the death of the primary beneficiaries.

For example, some people will extend the line of beneficiaries of the Trust to include children of their children (i.e., the testator's grandchildren) but exclude their children's and grandchildren's spouses from being beneficiaries, to protect assets of the Trust from being subject to family law proceedings.

Leaving additional bequests in your estate can also be achieved via a trust, by including a Charitable Trust in your Will. An estate planning lawyer can assist you with including this different type of Trust in your Will and will often liaise with your chosen charity to see if this will suit them.

4. Identify the terms and structure of the Trust

You will need to specify which assets specific beneficiaries are entitled to, as well as when they can access them. One of the benefits of creating a Testamentary Trust is you can restrict access until a beneficiary turns 18, but you can give the Trustee permission to release money before this age to use for the beneficiary's tuition fees or living expenses. You may also decide that 18 is too young for the beneficiaries to start receiving income from the Trust and could raise this age to 21 or 25.

5. Execute the Will

A Will incorporating a Testamentary Trust is valid and in effect once the will has been drafted and validly signed in front of two independent adult witnesses.

There is then nothing further to do until such time as the testator passes away.

Post-death:

1. Notify the beneficiaries

Following the death of the testator, the Executor of the Will should notify the beneficiaries that they are named in the Will via a Testamentary Trust.

Some Wills make the Testamentary Trust optional, and a beneficiary may decide to still receive their inheritance in a personal capacity. If this is the case, the beneficiary should obtain financial and legal advice regarding the implications of refusing the Trust.

2. Engage an Accountant and apply for a Tax File Number (TFN)

All Trusts in Australia must have an associated TFN, as this is used on the tax returns for the Trust.

The accountant can apply for the TFN, and provide financial advice regarding the assets, how best to transfer them to the Trust, and any potential tax implications at the time of transfer as well as strategic advice regarding the ongoing management and distribution of Trust income to beneficiaries.

3. Administer the Estate

The Executors of the Will should proceed with applying for Probate of the Will and redeeming assets of the Estate.

Once this process is complete, the assets that form part of the Testamentary Trust can be transferred to the Trust with the assistance of the accountant or tax lawyer.

FAQ's

How much does a Testamentary Trust cost in Australia?

Drafting a Will with a Testamentary Trust is a complex process and can cost anywhere between $1,000 to $8,000 in legal fees and will usually only be done by a specialist person- normally an estate planning lawyer.

Once the Will has been drafted to include a Testamentary Trust, there should be no further fees payable as the Trust does not begin until the testator dies.

Following the death of the testator, there will be some ongoing administrative costs for maintaining and operating the Trust, like accountancy fees for preparing annual trust tax returns.

When should you set up a Testamentary Trust?

A Testamentary Trust should be set up during the estate planning process, when a Will is being drafted.

If there is an existing Will, this might be able to be updated to include a Testamentary Trust, if done correctly by an estate planning lawyer.

Who should have a Testamentary Trust?

Generally, it would be appropriate to set up a trust if you are in a stage of life where significant assets have been accumulated (or will be accumulated) or if you need to protect your beneficiaries.

Whether a Testamentary Trust is suitable depends on each person's individual circumstances, and the circumstances of their proposed beneficiaries.

Recap

A Testamentary Trust Will is essentially trust which is created by a Will and comes into effect after someone has passed away. Depending on the wording of the Will, and the wishes of the testator, the entire estate may pass into a Testamentary Trust, or only certain assets. If the trust is discretionary, the amount or timing or what a beneficiary receives can also be dependent on the trustee, and what this person deems appropriate.

When writing their Will, the testator can also set the terms and conditions around the ongoing management of the Trust by the trustee, and who the beneficiaries of the Trust will be. As most Trusts can exist for up to 80 years, it is important to consider who the beneficiaries of the Trust would be if the primary beneficiary happened to pass away during that time.

While offering the testator peace of mind that their assets will be protected, setting up a Testamentary Trust will also offer some relief to beneficiaries in the form of tax benefits. This means the money may be taxed at a lower threshold depending on the income and age of nominated beneficiaries.

How can Safewill Legal help?

Safewill Legal is a specialist Wills and Estates law firm and can assist with the creation and management of Testamentary Trusts.

Safewill Legal also provides the most affordable and comprehensive fixed fee Probate service in Australia and can assist with Probate of an estate where there are Testamentary Trusts involved in the Will.

Our team is local and ready to provide you with complimentary guidance about where to start. Start a live chat or call us on 1300 942 586.

The information contained in this article is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from an estate planning lawyer.