What is a testamentary trust?

A testamentary trust can assist in controlling any inheritance you would like to pass to your beneficiaries, as well as potentially helping them achieve certain tax advantages.
A testamentary trust is a type of trust set up to take effect after you die. It is created by a ‘testamentary’ instrument or document such as a will – hence the name. Testamentary trusts could be worth considering when planning your estate, especially if you want additional protection for the assets you plan on leaving to your beneficiaries when you pass away.

The assets contained in a testamentary trust are overseen by your nominated trustee, whose job is to distribute the trust’s assets to your beneficiaries in line with your wishes. The trustee can be someone you know, or you can nominate an independent professional. You can also set out how you want the assets to be distributed in your estate plan, or instead leave it to the discretion of the trustee under what’s known as a discretionary testamentary trust.

A testamentary trust can hold a wide variety of different assets. It can be established using specific assets outlined in your will, a designated portion of your estate or the entire balance of the estate. You can even establish multiple trusts in the one will, which means you could have trusts with different conditions to meet the varying needs of your beneficiaries. If you have multiple trusts, you can also select different trustees to manage them.

While superannuation death benefits usually don’t form part of your estate, there are some circumstances when you may want them distributed through a trust. To do so, you could consider setting up a superannuation proceeds trust – a special type of testamentary trust established to receive super proceeds when you pass away.

Why might you use a testamentary trust?

Testamentary trusts may have a range of uses and benefits, but some of the main reasons people tend to use them are:

• tax planning
• asset protection
• providing for the financial needs of children aged under 18
• providing for loved ones with special needs well into the future.

Let’s take a closer look at how a testamentary trust can achieve these goals.

Using a testamentary trust for tax purposes

One potential advantage of using a testamentary trust is that it can be used to achieve certain tax outcomes. As the ATO explains, 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 originating from a deceased estate that is distributed to a child under 18 via a testamentary trust is usually taxed at adult marginal rates. Depending on the child’s total income, their income from the trust could also potentially be eligible for the low-income tax offset, which can be as much as $1,500.

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Using a testamentary trust for asset protection purposes

Another possible benefit provided by testamentary trusts is that they can help protect assets from being claimed by people or organisations they were not intended for, such as in the event of a divorce or by 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, or be counted as their assets in the instance of a divorce.

However, placing the death benefit (or other assets) in a testamentary trust may provide your dependents with protection due to the fact that, generally speaking, creditors or the Family Court can’t claim assets or income held in a trust. This is because assets in a trust are generally not considered to be the property of any one individual – the beneficiary doesn’t actually own the assets while they are still in the trust.

Other circumstances in which a testamentary trust could help protect assets include:

• for children who may not yet be capable of managing the deceased estate or the assets in it themselves, including to ensure a standard of education or regular income for their upbringing.
• for beneficiaries who are in a high-risk profession or business where negligence claims are possible.
• for dependents who may experience issues such as gambling, addiction or misuse of finances.
• for dependents with a disability who may not be able to manage the estate.

Potential disadvantages of a testamentary trust

Testamentary trusts are not for everyone, and it is worth weighing up the pros and cons and potentially talking to a professional before making a decision. For example, there are usually some costs associated with administering a testamentary trust, particularly if you choose to appoint an independent professional as the trustee. You will need to determine whether the income from your estate will be enough to cover these fees while still providing for the beneficiaries.

There are also tax considerations for the beneficiaries, whereby you or any legal or tax professionals you appoint will need to consider the beneficiaries’ other income to determine how much tax will be payable on the benefits they will receive from the trust. There may also be tax implications for the exemption from capital gains tax on property if it is held in the trust.

Also, keep in mind assets in a trust are managed and distributed as the trustee sees fit – unless you specify conditions for release, or for how the trust should be managed in your will or estate plan. So it is a good idea to choose a trustee you trust, or appoint an independent professional who will have your beneficiary’s best interests in mind. You may also want to seek independent legal advice, to help ensure you set up the trust to achieve what you want it to.

Ultimately, it is a good idea to seek financial and legal advice, as well as talk to your family and dependents before making a decision for your estate or your superannuation.

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