The world of estate planning can be incredibly complex, doubly so considering the deep emotions involved when crafting your intentions for when you pass. Intentions rarely ever stay consistent over time either, so ensuring that your will is up to date is the best way to make sure they’re followed.
But is there anything else you can do to make sure your assets are distributed in the manner you wish? What about the tax implications?
Enter the testamentary trust
A testamentary trust is a type of discretionary trust contained within the will and only becomes active once the will-maker passes away. The trust effectively takes the place of the beneficiaries of the will. So instead of assets passing directly to the beneficiary in their own name, it is passed to a trust where it is held on behalf of them. Like any trust, a testamentary trust will have a trustee, this could be the beneficiary themselves, or it could be another person/s chosen by the will-maker to undertake this duty for a particular reason. The trustee will manage the assets within the trust for the benefit of the beneficiaries whilst ensuring that the actions of the trust uphold the requests made in the will.
The primary function of a testamentary trust is to prevent estate assets from being transferred directly to the named beneficiary. This could be for multiple reasons including asset protection or tax efficiency.
Advantages
Protection from Re-Marriage
As the inherited assets aren’t technically owned by the beneficiary with a testamentary trust, this leads to a raft of asset protection benefits not applicable if distributed to their own personal name.
Consider a scenario in which the sole beneficiary of a will is the deceased spouse. This spouse then decides after some time to remarry or enter a de facto relationship. If the assets from the first marriage were inherited personally, they would then be at risk of passing to the new spouse or their family. This could be to the detriment of the original will-makers’ children. If the will-maker utilised a testamentary trust, the matrimonial assets could be kept on trust for the benefit of the widow until she/he dies at which point the benefactor becomes the children/grandchildren. The trust helps to ensure that the assets remain within the bloodline family instead of being diluted by potential future relationship breakdown.
Assets within a testamentary trust may also be protected against family law litigation borne from relationship breakdown of a beneficiary. This assumption has been tested in the past, and since the control of the trust was directly separate from the beneficiary, the assets within were not considered to be part of the matrimonial property eligible to be distributed under a family law asset division. The primary point in this scenario for constructing a will was the fact that trusteeship and thus control of the assets was separate from that of the beneficiary. If they were one and the same, the judge’s decision may have been different.
Protection from legal claim & bankruptcy
Similarly to the previous section, a properly structured testamentary trust can protect the beneficiary from third party legal claims against them. As the assets in the trust can be legally seen as not belonging to the beneficiary, this would protect the asset from a liability claim for example.
In a similar vein, being proven to not control the trust assets may prevent the beneficiary from needing to realise them in a bankruptcy scenario.
Centrelink
Again, like the above, the lack of control over the assets within the trust will ensure that Centrelink does not assess it against the assets test when making determinations for social security eligibility.
Managing money for those not capable
The lack of control over funds is important in this example, but in a different sense. Sometimes beneficiaries may not physically be able to manage the inheritance on their own (such as children or those with a disability) or, may just not be trusted to manage the money appropriately (addiction issues, history of money issues etc). A testamentary trust will allow the will-maker to appoint a suitable trustee to manage the assets on behalf of the beneficiaries either in perpetuity or until which point they become capable of managing it themselves.
Disadvantages
Changes to excepted trust income
Prior to 1 July 2019, any income from a testamentary trust was considered excepted trust income when distributed to a minor under 18. This had the effect of applying the standard income tax treatment to this income, including access to the standard tax-free threshold. This was starkly different from how virtually any other trust distributions were taxed when received by a minor as seen below:
Clearly, accessing the standard adult tax rates for testamentary trust distributions to children was a very large benefit to including such a trust in your will.
However, in 2019 the Treasury Laws Amendment (2019 Measures No. 3) Act 2020 (Cth) was passed. This limited how and when distributions could continue to be treated as excepted income where minors are taxed at standard marginal rates.
Whilst some distributions can continue to be treated as excepted income, such as those directly from the original deceased estate, it is not nearly as simple as it was prior to 2019.
Cost to set up and maintain
The addition of a testamentary trust adds complexity to the drafting of a will and thus will increase the cost. Looking across the solicitors that publish their prices, the average for a single will without a testamentary trust is around $600 – $1,200. Adding the trust seems to add at least $1,000 to the total cost.
This is not the only associated cost either. Once the trust becomes active (upon death) it will need to be administered annually. This will be at least an annual tax return but could include professional trustee fees and investments management costs.
Requirement of appointing a suitable trustee/s
Who do you trust to manage the money for your family after you’re gone? The role of a trustee is an important one and cannot be forced upon anyone, it must be freely accepted.
What if your trust specifically restricts access to capital for beneficiaries, or places guidelines of the use of the funds? Who can you trust to maintain these wishes even when potential disappointment or coercion may occur from the beneficiary?
You can of course appoint the beneficiaries themselves as trustees (provided they are eligible). If this role is shared, this may require some cooperation between multiple parties which can often disintegrate when large sums of money are involved. If this is an intention, keep in mind that the asset protection benefit of the structure may be muted due to the beneficiary and the trustee being one and the same.
You may also choose to utilise a professional trustee service to outsource the role. This adds a level of impartiality and ensures that your wishes are more likely to be fulfilled. This does come with an added cost, however.
Choosing a trustee is arguably just as important as choosing who gets what. A way to minimise dispute between future beneficiaries/trustees could be to ensure that your wishes and their roles are clearly communicated at the time of will preparation.
Capital Losses
Like any other trust, assets that are sold at a loss cannot be distributed to the beneficiaries in order to offset personal capital gains. Capital losses within a trust can only be used to offset the gains made within the trust itself.
Summary
In summary, a testamentary trust is a powerful estate planning tool and can help ensure that a person’s wishes are fulfilled after their passing. However, there are certain disadvantages to be aware of before including one in your own will.
Any information contained here is not a substitute for qualified legal advice. Before making any decision, we recommend you consult with an appropriately qualified legal practitioner to receive personalised advice on your situation.
