A testamentary trust is a trust created by will. It is usually a discretionary trust.

The testator of a will creates a trust and directs the trustee to hold property in accordance with the terms of the testamentary trust for specified beneficiaries. At some future time the trustee distributes the property to the beneficiaries of that trust.

Testamentary trusts are often recommended by financial planners and accountants. They are very useful for parents of small children (minor beneficiaries). Testamentary trusts tend to be driven more by the needs of the beneficiaries than by tax considerations. If a testamentary trust fails, the property will usually be held on resulting trusts for the testator’s residuary estate.

A testamentary trust has two main advantages for a will maker and the nominated beneficiaries asset protection; and income splitting.

Asset protection

Many clients are concerned about protecting their assets. They want to make sure that the assets remain within the family and are used to benefit family members.

In particular, clients are concerned about:

(a)  their beneficiaries becoming bankrupt, especially those that are involved in high risk businesses;
(b)  their beneficiaries becoming divorced and their assets being split in the divorce;
(c)  spendthrift or minor children;
(d)  ensuring that the surviving spouse will pass on their assets to their children upon that person’s death; or
(e)  looking after children and disabled relatives.

The advantage of a testamentary trust is that the assets are owned by the trustee, and the benefit of the income and capital of the trust passes to the 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 terms of the testamentary trust are set out in the will.

Taxation benefits

Testamentary trusts can benefit where people have children under 18 and a sizeable estate. The estate may be sizeable as the result of the sale of a business, from amounts held in a superannuation fund, or from the proceeds expected to be received from an insurance policy.

Children under 18 receiving income from a testamentary trust are taxed as though they are adults. Distribution of income to minors is taxed in the hands of minors at normal marginal rates. They therefore get the benefit of the tax-free threshold and low rates of tax. All family members may utilise their income tax free thresholds. Any income, capital gains and franked dividends can be distributed among all the family beneficiaries each year in the most tax-efficient way. The tax concessions also apply to any income and capital gains derived from assets acquired from the reinvestment of moneys received from the original inherited assets.

4  Precedents Available

1. Letter advising testamentary trust
2. Letter enclosing will and signing instructions
3. Will creating one testamentary trust
4. Will creating multiple testamentary trusts