A testamentary trust may be established under the terms of a will. It is not the same trust as the deceased estate and may last for many years after the deceased estate has been fully administered.
Although assets of the trust may be controlled by the intended beneficiary, they do not form part of that beneficiary’s estate. Therefore considerable benefits may arise from establishment of a testamentary trust.
It is common knowledge that the testamentary trust is effective in estate planning, as it reduces tax payable by the beneficiaries.
However there could be complications in respect of the testamentary trust if not drafted accurately.
What is a Testamentary Trust Will?
A testamentary trust exists when a trustee (a person or an entity) holds property and assets for the benefit of a beneficiary or beneficiaries in a will. A testamentary trust will only become effective as at the date of death of the testator.
The most common types of testamentary trusts are testamentary trusts for the benefit of minors and discretionary testamentary trust.
Any person over 18 years of age can be appointed as a trustee and you can also have more than one trustee. The trustee has effective control of the trust and distribution of income and capital of the trust and so they should be a person whom you know and trust to look after the best interests of the beneficiaries. Often the beneficiary of the trust will act as one of the trustees. Where a trust is being incorporated into a will for asset protection reasons (for example, to protect assets from erosion due to a family breakdown or potential insolvency) it is important to be realistic about the choice of trustees. In such instances it may not be appropriate to appoint the beneficiary as a sole trustee of their trust. You can appoint someone independent to act as trustee (either alone or jointly with the beneficiary) to protect the beneficiaries interests.
The beneficiaries are the individuals entitled to receive income and/or capital from the trust. As the trust is ‘discretionary’ it is up to the trustee which beneficiaries receive distributions from the trust. There is no restriction on who can be a beneficiary and it is common to find a primary beneficiary nominated (such as a spouse or child), with secondary beneficiaries including the primary beneficiary’s children, grandchildren, other blood relatives and associated companies and trusts.
Generally the testamentary trust is structured so that the trustee has full discretion to make distributions of capital at any time; however this will depend on the reason for establishing the trust. For instance, where the trust is set up to provide for the surviving spouse but ultimately preserve the assets for the children, the trust may be structured so that the surviving spouse can receive income only but the capital is preserved for the children.
Increasingly, the traditional husband and wife will i.e. each to each other and then to the children is being replaced by a testamentary trust controlled by the surviving spouse under which the spouse and children are potential beneficiaries. Wills along these lines can, if the funds in the trust justify it, provide that on the death of the spouse, sub trusts come into existence for the benefit of each child and that child’s family (and would be controlled by the child concerned).
Advantages of a Testamentary Trust Will
Flexible Nature of Testamentary Trusts
Testamentary trusts are flexible and can be tailored to suit the particular circumstances of each case. For instance if the beneficiary has a personal problem, such as a gambling or drug addiction, a testamentary trust can protect the assets from the beneficiary whilst provide care and treatment for the beneficiary or the people relying on the beneficiary such as beneficiary’s children.
Further Testamentary trust can direct the different streams of incomes to different beneficiaries.
Asset protection is usually high on the list of concerns in most people’s mind when drafting their will.
The importance of asset protection arising from testamentary trusts particularly manifests in family breakdowns and bankruptcy.
The Family court has jurisdiction to make orders in respect of trusts which would be binding on third parties including trustees of a testamentary trust.
It appears that the approach of the Family Court is to treat assets of the trust as a financial resource for the party who is the beneficiary under the trust rather than as part of the pool of assets, essentially making it harder for the divorcing spouse or de facto of a beneficiary to have access to the assets.
In bankruptcy matters, the establishment of a testamentary trust can protect assets of an insolvent beneficiary. Had the assets been given to the beneficiary as an absolute gift under the will, the asset would have transferred to the trustee in bankruptcy.
In order to protect assets of a potential insolvent beneficiary care should be applied to nomination of suitable trustees.
Testamentary trusts could be particularly advantageous to beneficiaries who are minors.
Income Tax Benefits:
Firstly testamentary trust would allow income to be split between different beneficiaries which in turn will maximise taxation benefits;
Secondly income can be used for education, maintenance and advancement of a child or grandchild and thereby increasing tax savings by providing income to the minor.
Under a testamentary trust, beneficiaries under 18 years of age are taxed at normal adult tax rates This means that minor beneficiaries can enjoy the benefits of the tax-free threshold and progressive tax rates without worrying about the penalty tax rate (currently at 47%).
Whilst assets could be subject to Capital Gains Tax (CGT) if the testator sells them before his death, the assets will not incur CGT if passed to a testamentary trust by the testator.
This is particularly beneficial where the assets have significant capital gains over the years.
Hence a valuable company that made trust distributions over a number of years and often not in cash can be subject to CGT if the testator transfers the ownership during his lifetime. However, if a testamentary trust is in place, after the testator’s death the shares of the company can be passed to the testamentary trust and the dividends can be distributed by the trust to the beneficiaries.
Under the testamentary trust, trust assets can be transferred to beneficiaries without incurring CGT. The exemption from CGT only applies to assets of the trust that were owned by the testator when he died.
Cautionary Points about Testamentary Trusts in a Will
- Testamentary trusts can be complex
A will containing a testamentary trust is longer and has a more complex language. A will maker must be provided with sufficient legal advice and clarification to be able to approve or object to the terms of the testamentary trust. Accordingly the testator may decide whether or not a testamentary trust is a good choice for his or her will.
- Testamentary trusts can be contested
Whilst testamentary trust is a strategy to protect the assets and the beneficiaries, it may be contested by eligible persons such as spouse, former spouse, children, step-children and other eligible family members through a family provision application. Testamentary trusts are not a waterproof protection against family provision claims.
2018 Federal Budget Changes to Testamentary Trusts
From 1 July 2019, the concessional tax rates available for minors receiving income from testamentary trusts will be limited to income derived from assets that are transferred from the deceased estate or proceeds of the disposal or investment of those assets.
Income received by minors from testamentary trusts is currently taxed at normal adult tax rates rather than the higher tax rates that normally apply to minors. However, some taxpayers have benefited from the lower tax rates from assets unrelated to the deceased estate that have been injected into the trust.
This measure will clarify that adult marginal tax rates will only apply to minors in respect of testamentary trust income generated from assets of the deceased estate (or the proceeds of the disposal or investment of those assets).
The terms of a testamentary trust and the decision to include it in your estate planning are matters to be handled by professionals and after receiving sufficient legal advice.
For example what happens if the trustee of your testamentary trust is not the right person to take care of the affairs of your minor children or grandchildren who are beneficiaries of your testamentary trust?
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