Testamentary Trusts

Testamentary trusts can be very effective estate planning tools to assist in providing for spouses, children and grandchildren, and are becoming increasingly popular as more people become aware of their advantages.

A testamentary trust is any trust established under a will, but the term is usually used in the context of a discretionary family trust established under a will.

Why Are They Becoming More Popular?

Their increasing popularity arises from the very considerable benefits that can flow from their establishment and use, including the fact that although assets of the trust may be controlled by the intended beneficiary, they do not form part of that beneficiary's estate. Major benefits include the ability to protect assets and possibly reduce tax paid by beneficiaries from income earned from their inheritance — providing a greater level of flexibility and control over the distribution of assets.

CGT Benefits

Assets owned by the deceased that would have been subject to capital gains tax (CGT) had they sold them before death can pass through their estate to a testamentary trust without a CGT event occurring. If an asset was a pre-CGT asset, the trust receives a cost base equivalent to its market value at the date of death; if post-CGT, the trust inherits the deceased's cost base. This is particularly important where assets have significant unrealised capital gains, and provides a good opportunity to "reset" ownership of assets subject to CGT.

In addition, trust assets may be transferred to beneficiaries without incurring CGT (but only in respect of assets of the trust that were owned by the deceased when they died).

Income Tax Advantages

Income can be distributed from a testamentary trust to infant beneficiaries (under 18) and taxed in those children's hands at adult marginal tax rates, instead of the top marginal tax rate as would otherwise apply. With the tax-free threshold of $18,200 since 2013/14, testamentary trusts are even better vehicles, since children and grandchildren under 18 who receive income from one enjoy a tax-free threshold of $18,200 (or $20,542 with the low income tax offset) and adult marginal rates — without this provision, trust distributions to minors may only access a tax-free threshold of $416, with an effective tax rate of 66% up to $1,307 and 45% thereafter.

Flexibility, and Protection of Assets

The trustee can buy and sell underlying assets of the trust, and thereby enhance its value, without losing or endangering any tax advantage. We suggest it is desirable that clients provide the trustee with some guidelines about administration, carefully framed to avoid confusion or complications.

Testamentary trusts also provide a level of protection to the assets held in the trust, including against creditors of the beneficiaries, and in the Family Law Court in the case of a beneficiary's divorce — an inheritance held within a testamentary trust is unlikely to be the subject of a Family Court order in the case of a marriage break-up.

Protecting 'At Risk' Beneficiaries

It is not uncommon for people suffering a variety of disabilities to be unable to properly manage their financial affairs. Families may wish to ensure an adequate fund is set up to meet such beneficiaries' reasonable needs without affecting any pension rights — for people who are drug or gambling addicted, disabled, or simply unable to look after wealth left to them, a testamentary trust can be managed by a responsible and capable trustee acting for their benefit.

Summary

It is becoming much more common to steer away from the traditional will giving everything to a spouse and then to the children, replacing this with one or more testamentary trusts controlled by the surviving spouse and/or children. If the funds in the estate justify it, wills providing for testamentary trusts can provide that on the death of the spouse, sub-trusts come into existence for the benefit of each child and that child's family, controlled by the child concerned.

Testamentary trusts are a very powerful and useful estate planning tool. To find out more about how they can benefit you, contact us on (03) 9598 8699.