What is a testamentary trust, and how does it work?

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testamentary trust
Financial Advisory
By
Kieran Liston
Kieran Liston
Director | Adviser
August 30, 2021
6
minute read

We help you understand how a testamentary trust can help navigate a complex will situation

A testamentary trust provides you with greater peace of mind, by creating a structure within your will that delivers improved control over how the assets in your estate are distributed.

In this article, we’ll look at what a testamentary trust is, how they work, and the advantages and disadvantages of this structure.

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What is a testamentary trust?

A testamentary trust is a type of trust that’s created as part of a person’s will. It’s designed to come into effect when the person who makes the will dies. The testamentary trust manages or holds that person’s assets, and puts clear rules in place for the distribution to their beneficiaries.

To make the testamentary trust legally binding, a trustee is nominated upon creation of the trust. This can be anyone you choose, but it’s advisable to be someone who you and your beneficiaries can rely on to do the right thing by all parties.

It may sound like a will, but it differs in that it’s an actual investment structure. Any assets and items outlined in the will are legally held by the trust, and managed by the trustee, rather than the person making the will.

The key people involved

The key people involved in a testamentary trust are:

  • The will-maker. The person whose assets and estate will be held by the testamentary trust. While you’re a key person in the creation of the trust, the trustee takes responsibility for it after you pass on.
  • The trustee. This is the person nominated to control the trust on behalf of the will-maker. They manage the testamentary trust and is the one who determines which beneficiaries receive which distributions.
  • The primary beneficiary. This is the person for whom the trust is essentially created. It might be a spouse, a child, or another person close to the will-maker. The primary beneficiary is able to choose and remove the trustee (unless otherwise stated).
  • The potential beneficiaries. These are the beneficiaries who are eligible to receive assets or income from the trust. It might be siblings, grandchildren, or even elected companies or other trusts. This is an interesting one, as a testamentary trust can name a class of beneficiary, rather than individual names. This ensures that, for example, grandchildren can receive assets allocated to them. If there are none at the time of the trust being formed, these assets will be held for them until such a time that they come into existence.

The advantages of a testamentary trust

advantages of a testamentary trust

There are many advantages to a testamentary trust that make them a good option for those looking to secure their assets and belongings for their beneficiaries

Greater flexibility

A testamentary trust functions in much the same way as a discretionary family trust. As such, the trustee has the power to determine how the assets are distributed, if it’s not outlined in the will.

The trust can also be used by the beneficiaries to hold assets as investments, which is not something a will can provide.

It also allows for better flexibility when dealing with beneficiaries who may be temporarily incapacitated for any reason. In this manner, the family of the beneficiary is able to manage their assigned assets for them, rather than having an external party manage the process.

Improved asset protection

A testamentary trust operates as just that — a trust — so it provides a better level of asset protection for the will-maker and beneficiaries.  

The assets aren’t held in your or your family’s personal name, instead, they’re held within the trust. It’s a separate legal entity, which provides a level of protection against any potential court proceedings, legal action, or situations like bankruptcy. It can also provide a good level of protection against any interfamily issues. Things like navigating de facto living situations, messy divorces, or simply protecting your assets against a family member who’s known to be bad with money.

Improved protection for beneficiaries

There are a number of reasons you might set up a testamentary trust, but a big reason is often to provide safety and security for your beneficiaries.

This is certainly the case when including beneficiaries with disabilities in your will. A testamentary trust ensures that there are assets left for those beneficiaries, and that the trustee can distribute any income from the trust with their best interests in mind.

Tax-effective planning

The old saying that nothing is certain except death and taxes becomes starkly apparent when dealing with wills.

A testamentary trust ensures that your asset distribution is completed in the most tax-effective manner possible. As it’s a trust structure, the trustee is able to distribute any assets and income in a way that limits the amount of income tax that the beneficiaries pay.

It’s also eligible to receive a full capital gains tax exemption. When an asset that has made a capital gain is transferred from the executor of the will—or trustee—to the beneficiary, the ATO disregards any capital gain. There’s also the benefit of not paying any stamp duty on assets paid into your trust.

It’s also advantageous if your beneficiaries are minors. Minors are still taxed at full adult rates, but this also means that they can enjoy the tax-free threshold of up to $18,200. This is ideal for setting up children with paid school fees or other expenses in the future.

Flexibility in paying out super and life insurance

Another advantage of a testamentary trust is that you can declare your super and any life insurance as part of the trust. While you may have been able to receive your super tax-free, your beneficiaries won’t. But this enables your beneficiaries to receive these funds and take advantage of the trust’s tax rules.

The disadvantages of a testamentary trust

While a testamentary trust provides some good advantages, they do have their disadvantages too.

There is no immediate benefit for the will-maker

This is much like a regular will: you’re putting plans in place to look after your family and loved ones when you’re not around. However, as a testamentary trust only comes into effect after your death, there are no immediate tax or asset protection benefits available to you.

It can cost more than a will

A testamentary trust is a business structure, so it’s likely going to be more complex than a regular will. It will also involve more financial administration, and will require ongoing administrative fees.

They’re a lot more complex

A testamentary trust is advantageous when dealing with complex asset distribution, however, if your estate doesn’t involve complexity, the administration requirements of a testamentary trust may not be worth it.

The final word

As you can see, a testamentary trust can be a good vehicle to provide security and certainty around who receives your assets when you’re no longer around. They provide you with tax-effective planning, and greater flexibility in dealing with a complex estate.

You’ve spent a lifetime building your wealth—a testamentary trust puts plans in place to ensure the right people can receive it.

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