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      The Ins and Outs of Testamentary Trusts

      A Testamentary Trust is a Trust that Arises from the Estate of the Deceased and is Contained in the Will to Protect the Assets of the Family

      A testamentary trust is commonly used by estate planning lawyers to protect the assets of the family from creditors, family law actions and, at the same time, provide flexibility in relation to the distribution of the estate. In essence, a testamentary trust is a trust that arises from the estate of the deceased and is contained in the will. As such, the terms and conditions of the trust, including the appointer, income and capital beneficiaries, trustee, and so on, are to be designated in the will of the deceased. The benefits and limitations are discussed below.

      Benefits

      • Control is held by the trustee of the testamentary trust and obviously the person who has the power to appoint and remove the trustee is called the appointer of the trust.
      • It is built for the purpose of looking after the family and others on the death of a family member, with income and capital distributed by the trustee to a group of family or non-family beneficiaries. Generally, the testamentary trust will require the trustee to look after family members in a specified way, rather than provide the trustee with complete discretion.
      • It can be built to be blood relative specific preventing dissipation of family wealth outside of family lineage.
      • The trustee is able to look after capital and income beneficiaries differently. The trustee may distribute a capital gain to one beneficiary and a dividend to another, while a third may receive property income, depending on the terms of the trust deed.
      • A capital gains tax discount of 50% applies to any assets disposed of by the trustee provided the trustee has held them for more than 12 months. Although the trustee claims the discount, they distribute the pre-tax capital gain to the beneficiary. This enables the beneficiary to claim the discount in their own hands and, more importantly, offset the capital gain with any capital loss that they may have from the disposal of assets in the current or prior years.
      • Assets are protected from creditors. Any assets in the testamentary trust may be protected from creditors of the potential family beneficiaries.
      • If structured correctly assets in the Trust may not form 'matrimonial property' for family law purposes providing protection in the event of a family law dispute.
      • The trustee of a testamentary trust may be in receipt of superannuation benefits on the death of a member of a superannuation fund with those benefits to be held for the use of the deceased’s dependant beneficiaries.  Any such receipt by the trustee of the testamentary trust is tax free.
      • Minor beneficiaries are not subject to penalty taxes and are taxed just like any other ordinary taxpayer.

      Drawbacks

      • Trusts are complex structures, particularly when different types of income and capital are distributed among beneficiaries under a wide-ranging trust deed. This means costs of running a testamentary trust may be substantial but any structure providing control will.
      • Where specific requirements are built within the trust deed (eg each child to receive a set amount of income each year), the drafting of the legal document is crucial and a poorly drafted deed will create more problems than benefits.
      • All income and capital gains must be distributed annually or the testamentary trustee pays tax on the income at the top marginal tax rate of 45%. In the case of a trust with different income and capital beneficiaries, this means that, in terms of capital gains made by the trust, it must choose one of the following options and still balance between both types of beneficiaries:
          • distribute capital gains to capital beneficiaries whenever made which reduces the asset base for the income beneficiary;
          • distribute capital gains as part of the income of the trust to the income beneficiary if the income of the trust includes assessable capital gains;
          • keep it in the trust with the trustee paying tax at 45%; and
          • keep it in the trust with the capital beneficiary paying tax with distributions recapitalised.
      • Income distributed from the trust is subject to tax at the beneficiaries’ marginal tax rate, although imputation credits on dividends received and passed through to a beneficiary will shelter some of the tax payable. There are no tax concessions provided to beneficiaries of a testamentary trust except that minors are taxed as ordinary taxpayers.

      Please be advised this is general information only, and is not to be taken as legal advice. If you would like more information, or have a legal query, please contact Abbott & Mourly directly.
      Reviewed: 17/01/2024