Testamentary Trusts

Should you consider a testamentary trust in your Will?

A testamentary trust is a trust established in a will. It involves a trustee holding property for the benefit of beneficiaries selected by the will-maker on terms and conditions set by the will-maker.

A discretionary testamentary trust is one where the trustee has discretion to choose which beneficiaries share in distributions from the trust fund. This enables considerable flexibility, especially when it comes to minimising the payment of tax, unlike when an outright gift is left to a beneficiary in a will.

A major advantage of testamentary trusts is that concessional rates of tax apply to minor children who receive income from testamentary trusts. This means that distributions of income to children are taxed using the adult tax-free threshold ($18,200 per year) and marginal rates of tax.

A simple example showing the type of flexibility and tax advantages that can be achieved with a testamentary trust is as follows.

Assume you have one son who has two children and you leave your estate to your son as trustee of a discretionary testamentary trust. The beneficiaries of that trust are your son and his two minor children. On your death you leave an estate of $2 million which is invested and returns $150,000 per year. Assume $50,000 is distributed to each beneficiary. Then the tax payable is, ignoring the Medicare levy: 

 

Beneficiary

Son

Child 1

Child 2

 

 

Taxable Income

$   50,000

$   50,000

$   50,000

$150,000

 

Tax Liability

$   7,797

$   7,797

$   7,797

$ 23,391

Each family member has the benefit of the $18,200 tax-free threshold so that the total tax bill for the family from income from the testamentary trust is $23,391. If you had just left the whole of your estate to your son, then the tax he would pay on the income earned from his inheritance would be $42,997.  

This is a tax saving of $19,606 each year for your son’s family. The strategic use of a testamentary trust could pay for the education of your grandchildren in tax-free dollars.

Discretionary testamentary trusts are also an important tool for the protection of assets, especially when you have a beneficiary in your will who suffers from a disability or is not capable of handling financial matters. An independent trustee could be appointed to manage a testamentary trust for a vulnerable beneficiary.

Discretionary testamentary trusts are not suitable for all will-makers. If you are interested in including a testamentary trust in your will you should get legal advice about whether it would be appropriate in your circumstances.