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What is a Testamentary Trust?

Testamentary Trusts: What you need to know

What is a Testamentary Trust

A testamentary trust is a trust that is created within and by your Will but does not take effect until your death. It is a type of discretionary trust, as the Trustees have full discretion about who benefits under the trust and how the assets in the trust are invested. Moreover, it differs from a family trust (also known as an inter vivos trust), as a family trust is created by deed and commences during your lifetime.

A testamentary trust may be created using specified assets, a designated portion of your estate or the entire remaining balance of your estate. In addition, a testamentary trust can continue for a period of 80 years, if so required, but it is also possible for the testamentary trust to vest at any earlier date if the trustee so decides. Further, multiple trusts may be created by the one Will.

Some Important Terms:
  • Testator – the person (male) who makes a will or testamentary trust, testatrix if female, and who must be 18 years old (the minimum age for a person to make a Will).
  • Executor(s) – the person(s) who represents you after your death and does everything necessary to carry out the instructions you have set out in your Will.  In carrying out your instructions the executor is referred to as ‘administering your estate’.
  • Trustees – are appointed by the Will, and are responsible for administering the trust on an ongoing basis—you can appoint one or more trustees. 
  • Beneficiaries – the person(s)who the Will says are to receive your assets and are to benefit from the testamentary trust.
  • Executed – happens after the testator and the appropriate witnesses have finalised your Will or testamentary trust by signing them.
  • Dying intestate –  happens when a person who dies without making a Will or testamentary trust.
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What are the Advantages of a Testamentary trust

There are three significant advantages for a testator and the people nominated as beneficiaries:

  1. Flexibility for Beneficiaries,
  2. Taxation advantages from income splitting, including capital gains tax,
  3. Protection of the assets under the trust from any financial or other difficulties that the beneficiaries may suffer from.

Flexibility for your beneficiaries:

The trustee may distribute capital and income to any nominated beneficiary at any time and in any proportion. In addition, the trust can be wound up at any time or kept open for an extended period of time. Hence, a testamentary trust gives the beneficiaries both flexibility and control over when they take their inheritance.

The Schedule forms part of the trust and offers a range of options for a testator. In particular, the testator can allow for the trustees to have maximum discretion in respect of what the funds under the trust can be used for, or it can be more specific and restrictive. These are referred to as the Powers of Investment.

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Taxation & Income splitting:

The main tax advantage of using a testamentary trust is that any income, capital gains and franked dividends can be distributed among all your family beneficiaries each year in the most tax-efficient way. Moreover, a trust does not have to pay income tax on income that is distributed to the beneficiaries but does have to pay tax on undistributed income. 

The trustee is free to distribute trust income to as many beneficiaries as possible, and in proportions that take best advantage of those beneficiaries’ personal marginal tax rates. Then, the beneficiaries pay the tax on distributions made to them.

One of the key considerations in deciding whether to establish a testamentary trust is where the testator or testatrix has children who are minors. In the case of family trusts, minors are taxed at penalty rates to discourage parents from income splitting with their children. This is not the case in testamentary trusts where minors are taxed at normal adult rates.

Asset protection:

The significant advantage of a testamentary trust is that the assets under the trust are owned by one or more personsthe trustee(s), whilst the benefit of the income and capital of the trust passes to the nominated beneficiaries. This separation of control and benefit allows testamentary trusts to protect assets from any legal action involving the beneficiaries and/or misuse of those assets. The only way that a client can ensure that the assets are fully protected is to have at least two trustees and an independent trustee, together with the primary beneficiary.

The effect of this is that the assets under the trust are protected in situations such as:

  • the beneficiaries becoming bankrupt,
  • beneficiaries becoming divorced and their assets being split in the divorce,
  • the beneficiaries demonstrating reckless and hedonistic spending,
  • one or more of the beneficiaries are disabled children.
Other benefits:
  • If you have a beneficiary who has an intellectual impairment, you could leave part of your estate for that person’s benefit by naming that person as the primary beneficiary of a testamentary trust with a family member, professional adviser, or a trustee company as the trustee.
  • When an intended beneficiary faces bankruptcy, an inheritance for that beneficiary through a testamentary trust will not form part of the beneficiary’s estate for bankruptcy purposes.
  • Assets held within a testamentary trust are unlikely to be the subject of a court order in the case of beneficiaries experiencing a break-up of their marriage although they may have some effect on the terms of the property settlement.

Issuance of Orders

Once the court approves the consent orders, it will issue a sealed copy of the orders to both parties. These orders have the same legal effect as if they were made by a judge after a contested hearing.

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Need help with your Will and Testamentary Trust?

AussieLegal offers a range of estate planning products such as Legal Will PlusTestamentary Trust PlusPowers of Attorney Plus, and Enduring Guardianship Plus services to help you plan for end of life. Our experienced estate planning lawyers and paralegals will help you complete your estate planning documents, so you can have peace of mind that you and your beneficiaries are well taken care of should an unforeseen event happens.

Call us on 1300 728 200 to discuss your situation with one of our consultants.

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