What is a Testamentary Trust and what are the advantages and disadvantages of having one?
Published on September 11, 2023 by Josephine Heesh
A Testamentary Trust is a popular estate planning tool offering several advantages. In this article, we will explore what a Testamentary Trust is, its benefits, drawbacks, and situations where it might be appropriate for you to have one.
What is a Testamentary Trust?
A Testamentary Trust is a Trust established within a Will, and it only takes effect after the Will maker (called the testator) has died. It operates to pass assets into the Trust instead of directly to a beneficiary. The beneficiary who might expect to be named in the Will would be named as a beneficiary of the Trust, providing an added layer of control and protection.
A Will can create separate Testamentary Trusts for separate beneficiaries (for example each child of the testator).
What are the advantages of Testamentary Trusts?
1. Asset protection
One of the primary advantages of a Testamentary Trust is that it provides enhanced protection for the assets left to beneficiaries. The assets are held within the Trust, and the beneficiaries do not actually own any of the assets, they only become entitled to any trust capital and/or income after the Trustee decides to make a distribution to them. The Trust holds the legal title to the Trust assets and therefore depending on the structure of the Testamentary Trust, the assets are generally shielded from various risks. This could include protection from a creditor should a beneficiary fall into debt, protection from bankruptcy proceedings, and some protection from family law property proceedings.
2. Tax efficiency
A Testamentary Trust can offer potential tax benefits, particularly for families with minor children. Income distributed to minors through a Testamentary Trust is generally taxed at adult rates, (much lower than usual rates on child living trust income) potentially reducing the overall tax burden on the estate. There may also be benefits with Stamp Duty and Land Tax concession.
3. Control over distribution
The testator can specify conditions and rules for distributing assets to beneficiaries. This can be particularly useful when the beneficiaries are young, have special needs, or require financial guidance.
4. Continued management
The appointed trustee or trustees can manage the assets professionally, ensuring they are invested and distributed wisely, in line with the testator’s wishes.
What are the disadvantages of Testamentary Trusts?
1. Complexity and cost
Setting up a Testamentary Trust involves legal and administrative expenses, which may be higher than a straightforward Will. Moreover, the ongoing management of the Trust can incur additional costs. We suggest that the bequest should be a minimum of $500,000 to warrant a Testamentary Trust. The Trust must file an annual tax return and accounting fees are incurred.
2. Loss of direct ownership
Assets placed in a Testamentary Trust are not directly owned by the beneficiaries: adult children may much prefer a lump sum legacy to payout house mortgage, than a trust to invest.
3. Limited access to Capital Gains Tax (CGT) benefits
Testamentary Trusts may not always receive the same CGT benefits as living Trusts. The CGT concessions available to other types of Trusts may not be fully applicable to Testamentary Trusts.
Who might need a Testamentary Trust?
While Testamentary Trusts offer many benefits, they may not be necessary for everyone but they are useful for:
i. Families with young children – A Testamentary Trust can provide financial support to minor children while protecting the assets until they reach adulthood or a specified age.
ii. Vulnerable beneficiaries – If beneficiaries have a disability, lack financial maturity, or face potential creditor risks, a Testamentary Trust can ensure their long-term financial security.
iii. Asset protection – Those who want to protect their beneficiary from potential legal or financial risks, or addiction problems, might consider a Testamentary Trust, especially if there is significant wealth that is to be inherited.
iv. Tax planning – where income earned can be split with family members on lower incomes and allow the beneficiary to take advantage of lower marginal tax rates.
It is important that you speak with a lawyer to discuss your individual circumstances and decide based whether a Testamentary Trust is appropriate for you. You can contact us at Carroll & O’Dea Lawyers on 1800 059 278 or via our Contact Page if you need advice and one of our lawyers will assist you.
