What Is A Testamentary Trust & How Does It Work?

A testamentary trust can be a handy way to protect your dependants as well as potentially help them achieve certain tax outcomes in regards to income earned from any inheritance you leave them.

It can be a good idea to look at testamentary trusts when doing your estate planning, especially if you want additional protections for the assets you plan on leaving to your beneficiaries.

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What is a testamentary trust?

A testamentary trust is a type of trust set up in the event of your death, created by a ‘testamentary’ instrument or document such as a will; hence the name. Testamentary trusts are set up in order to hold assets and are overseen by a nominated trustee, who eventually distribute the trust’s assets to beneficiaries. However the manner in which this can be done depends on the manner of the testamentary trust.

There are a number of different types of testamentary trusts, but two of the most common ones are:

  • Discretionary testamentary trusts, which the ATO advises can be used in some cases for certain tax outcomes and asset protection
    • It is a separate trust to the deceased estate
    • The trustee has the discretion to distribute capital and/or income between a group of beneficiaries nominated in the will
  • Protective testamentary trusts, generally established for the benefit of someone who is otherwise unable to manage their own affairs.

A testamentary trust can hold a wide variety of different assets. It can be established using specified assets, a designated portion of your estate or the entire balance of your estate. You can even establish multiple trusts in the one will, which means you could have trusts with different provisions to meet the different needs of your beneficiaries.

While superannuation death benefits usually don’t form part of your estate, there are some circumstances when you may want them paid to your legal personal representative and distributed according to your will. You may even decide to create a superannuation proceeds trust, which is a special type of testamentary trust. But before you start planning how your superannuation will be handled when you pass away, you should make sure your super is currently in the right hands. You can compare super funds and find the right fund for you with Canstar.

The following table contains details of the superannuation funds rated by Canstar based on someone aged 40-49, with a super balance of $100k-$250k. This table has been sorted by one-year performance (highest to lowest)

Please note that the performance information shown in the table is for the investment option used by Canstar in rating of the superannuation product.

Why might you use a testamentary trust?

Testamentary trusts have a range of uses and benefits, but some of the main reasons people tend to use them are for tax planning and asset protection.

Using a testamentary trust for tax purposes

One potential advantage of using a testamentary trust is that they can be used to achieve certain tax outcomes. As explained by the Australian Taxation Office (ATO), in the case of a discretionary testamentary trust, the trustee could hypothetically choose to pay certain amounts to various beneficiaries with differing incomes, and in this way possibly minimise the tax paid on the total sum.

According to the ATO, income distributed to a child under 18 from a testamentary trust is usually taxed at adult marginal rates, rather than ‘penalty’ minor rates, which can be as high as 66 cents on the dollar on some income. Depending on the child’s other income, their income from the trust could also potentially be eligible for the low-income tax offset, which can be as much as $445.

The ATO advises that a testamentary trust itself usually does not have to pay income tax on income that is distributed to the beneficiaries, but does have to pay tax on undistributed income, usually at the highest marginal rate of 45%.

Using a testamentary trust for asset protection purposes

Another possible benefit provided by testamentary trusts is that they can protect assets against recovery from creditors. If an inheritance or superannuation death benefit is paid directly to a beneficiary, it could then potentially be susceptible to recovery or seizure by any creditors that person may have.

However, placing the death benefit (or other assets) in a testamentary trust may provide your dependents with protection against recovery due to the fact that, generally speaking, creditors can’t claim assets or income held in a trust. This may be helpful for beneficiaries who:

  • Are in a precarious financial situation
  • Work in a high-risk environment such as share-trading
  • Are currently dealing with divorce or a similarly fractious family issue

Ultimately you should definitely seek legal advice, as well as talk to your family and dependants before making any sort of firm plans for your estate or your superannuation. And like we said, the first step in considering where your superannuation will go when you pass away should be ensuring that you’re with the right super fund to begin with. You can compare super funds and find the right fund for you with Canstar.

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