A testamentary trust can be a valuable estate planning tool for protecting and managing assets after someone dies. It can help provide for spouses, children and grandchildren while offering greater flexibility over how an inheritance is distributed.
A testamentary trust is a trust created under a Will. It is commonly used to establish a discretionary family trust that begins operating after the Will-maker’s death.
What is a testamentary trust?
A testamentary trust allows assets from an estate to be managed by a trustee for the benefit of selected beneficiaries.
Unlike an outright inheritance, the beneficiary does not personally own the trust assets. Instead, the trustee manages and distributes the assets according to the terms of the trust.
| Traditional Will | Testamentary Trust |
|---|---|
| Assets pass directly to beneficiaries. | Assets are held and managed through a trust. |
| Beneficiary controls inherited assets personally. | A trustee manages assets for beneficiaries. |
| May provide less protection from financial risks. | Can provide additional asset protection benefits. |
Why are testamentary trusts becoming more popular?
More people are considering testamentary trusts because they provide greater control over how assets are managed after death.
Key benefits may include:
- protecting inherited assets;
- providing flexibility when distributing income;
- supporting vulnerable beneficiaries;
- potential tax advantages; and
- allowing assets to remain protected for future generations.
Capital gains tax benefits
Testamentary trusts may provide capital gains tax (CGT) advantages when assets pass through an estate.
Assets that would have triggered CGT if the deceased sold them during their lifetime may transfer into a testamentary trust without an immediate CGT event.
The tax treatment depends on whether the asset was acquired before or after CGT rules applied.
| Asset type | Potential treatment |
|---|---|
| Pre-CGT assets | The trust generally receives a cost base based on the market value at the date of death. |
| Post-CGT assets | The trust generally receives the deceased person’s existing cost base. |
For example, a family may own shares connected to a company or family trust. Those shares may have increased significantly in value over time.
If the owners transferred those shares during their lifetime, the transaction could create a CGT liability. A testamentary trust may provide another option after death, depending on the circumstances.
Trust assets may also transfer to beneficiaries without CGT in some situations. This depends on the type of asset and whether the deceased owned it when they died.
Income tax advantages for children and grandchildren
One significant benefit of testamentary trusts involves distributing income to minor beneficiaries.
Normally, minors pay higher tax rates on certain types of income. However, income from a testamentary trust may allow children under 18 to access adult tax rates in certain circumstances.
This can provide a more favourable tax outcome compared with ordinary trust distributions.
The tax treatment depends on current legislation and individual circumstances. You should obtain advice before establishing or distributing from a testamentary trust.
Flexibility for the trustee
A trustee can manage the assets held within the testamentary trust. This may include buying, selling or replacing investments over time.
This flexibility allows the trustee to respond to changing family circumstances and financial needs.
Many people also prepare a memorandum of wishes. This document provides guidance to the trustee about how they would like the trust to operate.
Asset protection benefits
Testamentary trusts may provide protection for inherited assets in certain situations.
For example, trust assets may receive protection from creditors of a beneficiary in some circumstances.
A testamentary trust may also provide protection if a beneficiary experiences financial difficulties, operates a high-risk business or faces bankruptcy.
Family law matters require careful consideration. Courts may consider trust assets during relationship breakdowns, depending on the circumstances.
Protecting vulnerable beneficiaries
Some beneficiaries may struggle to manage a large inheritance due to personal circumstances.
This may include people experiencing:
- disability or health issues;
- addiction concerns;
- gambling problems; or
- difficulty managing money.
A testamentary trust allows a responsible trustee to manage assets for the beneficiary’s benefit.
This structure can help provide ongoing financial support while reducing the risk that the beneficiary quickly loses their inheritance.
Testamentary trusts and modern estate planning
Many families now use testamentary trusts instead of leaving assets directly to a spouse or children.
A Will can establish one or more testamentary trusts that begin after death. These trusts may allow a surviving spouse, children or future generations to benefit from the estate.
For example, a trust may continue after the death of a spouse and later create separate trusts for each child and their family.
Frequently asked questions about testamentary trusts
Who can benefit from a testamentary trust?
A testamentary trust can benefit people named in the Will, including spouses, children, grandchildren and other selected beneficiaries.
Is a testamentary trust better than a normal Will?
A testamentary trust is not suitable for everyone. Whether it is appropriate depends on your assets, family circumstances and estate planning goals.
Who controls a testamentary trust?
A trustee manages the trust and makes decisions according to the terms set out in the Will.
Conclusion: Are testamentary trusts worth considering?
Testamentary trusts can provide significant flexibility and control when planning how your assets will be managed after death.
They may offer benefits including asset protection, tax planning opportunities and support for vulnerable beneficiaries.
However, a testamentary trust must suit your individual circumstances. Professional advice can help determine whether this structure is appropriate for your estate plan.
To find out more about how testamentary trusts can benefit you, contact us on (02) 9818 2888 or email [email protected].