A testamentary trust is a trust that is established by your Will. The testamentary trust comes into existence after you die. The rules of a testamentary trust are contained in your Will. No other legal formality or procedure is required to establish a testamentary trust.
A testamentary trust cannot be established by your beneficiaries after your death unless you provide for it in your Will.
The use of testamentary trusts in Wills has become more popular in recent times due to the following benefits they provide:
- They allow you to exercise control of the future use of your assets for various reasons. For example, they provide a means of protecting and administering assets for the benefit of your children or others under a legal disability.
- They allow for your assets to be protected from a beneficiary's creditors and matrimonial claims. If you simply gift or leave assets directly to beneficiaries who are at risk of claims from creditors or a matrimonial dispute, these assets increase the pool of assets at risk by those claims. For example, if a beneficiary becomes bankrupt or has a relationship breakdown, those assets, if held by them personally, can potentially be claimed by creditors or the ex-spouse. By using a testamentary trust, those assets are not held by the beneficiary personally. Instead, the assets are held in the testamentary trust for the potential benefit of the beneficiary and others. This way, if there is a risk of creditor or matrimonial claims at the time of death, the trustees of the testamentary trust can:
- To the extent that it is legally possible to do so, preserve those assets until the risk passes; and
- Pass control of those assets to the beneficiary at a later time, when the assets are less at risk of a likely claim.
- They provide a beneficial tax outcome. A testamentary trust has significant taxation benefits where children and grandchildren are aged under 18. Generally, the unearned income of persons under 18 years has a tax-free threshold of only $416; after that, income can be taxed at either 66% or at the top marginal tax rate depending on the level of income involved. However, income distributed by a testamentary trust to a minor beneficiary will be taxed at normal adult marginal tax rates. This means that, for the financial year ending 30 June 2019, each minor beneficiary can receive a tax-free distribution of $18,200 and normal adult marginal tax rates apply after that. This can be extremely beneficial in order to service, for example, a child beneficiary's school fees or living expenses. By way of example:
- Suppose you die under a 'normal' Will with no testamentary trust and your spouse receives $1,000,000 directly from your estate. If your spouse invests that money and earns, say, 7.5% per annum ($75,000) and was already earning $90,000 per annum from employment and/or other investment income, then they would likely pay tax of $27,750 (being the marginal tax rate of 37% for the 2019 financial year) on the $75,000.
- If, instead of receiving the $1,000,000 personally and directly and it is inherited by a testamentary trust controlled by your spouse, the income of $75,000 can be streamed amongst your children under 18 years of age. If those children earned no other taxable income, the family would be likely to pay tax on the $75,000 of:
- $15,922 per annum with 1 child, being a saving of $11,828 per annum
- $7,469 per annum with 2 children, being a saving of $20,281 per annum
- 3,876 per annum with 3 children, being a saving of $23,874 per annum
- There is no stamp duty payable on the transfer of property from your estate to your testamentary trust or on the establishment of your testamentary trust.
- There is no capital gains tax payable on transfer of property from your estate to your testamentary trust or on the transfer of the initial trust property of your testamentary trust to a beneficiary. However, the cost base and terms of acquisition rules should be considered separately.
- They provide for greater flexibility. We do not know what each beneficiary's personal and business circumstances will be when we die. Rather than receiving an inheritance in their personal names, a beneficiary may prefer to hold their inherited assets in another entity, such as a company or a trust. Because a 'normal' Will would leave assets directly to the beneficiary, the beneficiary may have to pay stamp duty and/or capital gains tax if an inherited asset is received by the beneficiary and then transferred to the preferred holding entity.
A testamentary trust is very much like a normal trust. One or more assets are given by the person making the Will (the testator) to a trustee or trustees to be held for the benefit of a beneficiary or beneficiaries on the written terms of the trust.
Testamentary trusts are usually discretionary trusts in that the terms of the trust usually provide the trustee/s with discretionary powers to distribute income or capital to the beneficiaries or a range of persons related to the beneficiaries. Given the considerable discretion afforded the trustee, testamentary trusts usually provide for another person or persons, known as an appointor, to be able to remove the trustee/s at any time in their discretion.
Due to the above powers, the selection by the testator of the most appropriate person(s) to be the appointor(s) and trustee(s) should ensure that the testator's intentions are carried out and that control of the testamentary trust is in appropriate hands. Where there is more than one beneficiary, the Will can establish a separate testamentary trust for each beneficiary.
You will also need to consider who should be Appointor after the death of the original Appointor.
If you would like to print this information please click here for PDF format.
The information provided in this information sheet does not constitute advice. The information is of a general nature only and does not take into account your individual financial situation. It should not be used, relied upon, or treated as a substitute for specific professional advice. We recommend that you contact Brentnalls SA before making any decision to discuss your particular requirements or circumstances.