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There’s a lot about our lives we can’t control. But a testamentary trust lets you have a say even when you’re no longer around. The question is, should a testamentary trust be part of your estate plan?
If it seems like our lives are becoming more complex, you could be right.
These days plenty of us have blended families, complicated business structures, and our wealth can be spread across a variety of assets. Just to add to the complexity, the people we wish to bequeath our estate to can also lead multifaceted lives.
While having an up to date Will can identify your assets and give clear instructions about who gets what, a testamentary trust goes much further. And in many respects it can let you have a voice long after you have passed away.
The concept of a trust can seem complex. So we’ve broken down the key points to help you understand what’s involved with a testamentary trust, and whether it could be the right option for you.
What is a testamentary trust?
Instead of your assets being handed over directly to individual beneficiaries – as is the case with many Wills, a testamentary trust holds assets for, on behalf of, your beneficiaries.
This is an important distinction, which as we’ll see, can play a vital role in the financial wellbeing of beneficiaries.
"A testamentary trust can also let you offer a vital helping hand in the upbringing of grandchildren."
Why testamentary trusts are becoming more popular?
Recent times have seen an uptick in the use of testamentary trusts – and with good reason. They can provide a number of benefits including:
- Control over how your assets are used in the future
Control can be especially important if you want to provide for the long term care of loved ones. This can especially be the case for beneficiaries who may need long term financial support such as a child with special needs.
A testamentary trust can also let you offer a vital helping hand in the upbringing of grandchildren. A testamentary trust can be used to make very specific bequests such as paying a grandchild’s school fees. In this sense a testamentary trust can be more effective than bequeathing assets directly to your adult children in a Will.
- Protecting your assets from a beneficiary's creditors and matrimonial claims
As noted earlier, assets held in a testamentary trust are not owned by a beneficiary personally. Instead, they are held in trust for the potential benefit of the beneficiary.
If a beneficiary becomes bankrupt the assets held in a testamentary trust cannot normally be claimed by creditors. That’s a very different situation than if you bequeathed assets to them personally. In the case of relationship breakdown, if the primary beneficiary is the trustee for the testamentary trust, these assets will be considered as part of the split but if the beneficiary is not a trustee, these may be protected. Careful wording and legal advice is required if this outcome is desired.
- Providing a beneficial tax outcome
A testamentary trust has significant taxation benefits where children and grandchildren are aged under 18.
Generally, any unearned (typically investment) income of youngsters aged under 18 years (minor) has a tax-free threshold of only $416. Above this, income can be taxed at either 66% or at the top marginal tax rate depending on the level of income involved.
Income distributed by a testamentary trust to a minor beneficiary will be taxed at normal adult marginal tax rates. This means that for the financial year ending 30 June 2022, each minor beneficiary can receive a tax-free distribution of $18,200, above which normal adult marginal tax rates apply. This can produce valuable tax savings, allowing you to plan your estate in a way that maximises the financial benefits for the people you care most about.
- Additional tax benefits
There is no stamp duty payable on the transfer of property from your estate to your testamentary trust or on the establishment of your testamentary trust.
Capital gains tax savings can also apply. No capital gains tax is payable on transfer of property from your estate to your testamentary trust, or on the transfer of the initial trust property of your testamentary trust to a beneficiary (the cost base and terms of acquisition rules should be considered separately).
- Flexibility
Death may be one of life’s certainties but none of us know exactly when we will pass away. That being the case we can’t be sure what the personal circumstances of a beneficiary will look like when we die. This is where testamentary trusts give a beneficiary more flexibility around options to hold their inherited assets in another entity such as a company.
By contrast, if you left assets directly to a beneficiary, they would likely have to pay stamp duty and/or capital gains tax if they choose to transfer an inherited asset to a separate entity.
“Each state has its own rules regarding how long a testamentary trust can last and this can vary from 80 years to in perpetuity.”
- Longevity
Each state has its own rules regarding how long a testamentary trust can last and this can vary from 80 years to in perpetuity. This allows the opportunity to provide for up to two, maybe more generations of family members.
- Generation skipping
Families can be very complicated with a whole variety of dynamics at work. And a testamentary trust can be used to skip a generation. In other words, you can ensure the majority (or part of) your wealth goes to grandchildren rather than adult children.
How do testamentary trusts work?
A testamentary trust is established by your Will. So it only comes into existence after you die.
You can choose which assets are to be held by the testamentary trust, with the exact rules of the trust set out in your Will via a trust deed. Where there is more than one beneficiary, your Will can also establish a separate testamentary trust for each beneficiary.
Most testamentary trusts are discretionary trusts. This gives the trustee some free rein about how the assets are to be used. It may sound compelling to provide strict rules, but a degree of leeway can be useful as the trustee may have to deal with unforeseen events.
Nonetheless, given the level of discretion a trustee has, most testamentary trusts name an ‘appointor’. This is another person(s) who has the power to remove the trustee/s if necessary.
“The trustee’s duties can include investing the trust’s assets wisely so that they generate a decent income, looking after the needs of beneficiaries, and keeping accurate and up to date trust records.”
What to be aware of with testamentary trusts
A testamentary trust is not suitable for everyone. A key reason for this is that accounts will need to be prepared for the trust each year, and a tax return lodged. These requirements bring their own set of expenses, and the trust needs to have sufficient assets to make the cost worthwhile.
It’s also worth noting that tax and trust laws can change. This can make it essential to have an expert review the trust deed from time to time to be sure everything is still in order, and the trust is still operating in the most tax-friendly way.
The importance of choosing a trustee
As we noted earlier, a testamentary trust can have a long lifespan. So it pays to give careful thought not only to who will act as trustee, but also to have succession plans in place for the trustee if they too should pass away.
In fact, selecting a trustee calls for careful consideration. The trustee takes on quite a bit of responsibility and depending on the circumstances, he or she may need good financial skills. The trustee’s duties can include investing the trust’s assets wisely so that they generate a decent income, looking after the needs of beneficiaries, and keeping accurate and up to date trust records.
A corporate trustee can be used in place of an individual(s). While this may have the advantage of independence, it can be more expensive as the trustee company will also incur annual costs.
Is a testamentary trust suitable to your estate?
Death, particularly our own, is hardly the stuff of upbeat conversations. And perhaps for this reason a lot of Australians neglect estate planning.
However, we shouldn’t just look at how our wealth will be managed during our lifetime, but also afterwards, when the assets we have accumulated are left to your estate.
Knowing if a testamentary trust is right for you, calls for expert advice, and it’s a decision that should be taken as part of your overall estate plan. Take a look at our information sheet on testamentary trusts, or talk to the expert team at Brentnalls SA about your broader estate plan.
Taking steps today can give you peace of mind that your assets will be used in the way you choose when you’re no longer around to call the shots yourself.
Discuss Further?
If you would like to discuss, please get in touch.
Disclaimer
The information provided in this article does not constitute advice. The information is of a general nature only and does not take into account your individual financial situation. It should not be used, relied upon, or treated as a substitute for specific professional advice. We recommend that you contact Brentnalls SA before making any decision to discuss your particular requirements or circumstances.
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