A traditional Will operates so that the assets of the deceased are immediately passed to the nominated beneficiary. This is adequate for many people but sometimes this can result in unintended outcomes such as assets being counted for CentreLink purposes or tax inefficient outcomes or assets becoming exposed to creditors if a beneficiary is in financial difficulty.

A testamentary trust gives much flexibility over the way in which assets are distributed from an estate. A testamentary trust is a discretionary trust established by a Will that commences at the date of death. If there are multiple beneficiaries, a testamentary trust can be established for each beneficiary’s share of the estate.

A testamentary trust is used to retain some or all of the deceased’s estate in a trust, rather than paying it out to beneficiaries. It is in effect creating a separate family trust for each beneficiary who can then determine how this is best for their individual circumstances.

A testamentary trust is not only relevant for the way in which assets are passed to children and grandchildren but also for the way in which assets pass to a surviving spouse. Where there are assets of reasonable value this can be of particular benefit by enabling the surviving spouse to allocate income to children and grandchildren in a more tax effective way.

Why use a testamentary trust?

There are several reasons why a person making a Will may not want to distribute their estate immediately to beneficiaries including:

• Significant tax benefits are obtained using a testamentary trust since minor beneficiaries can be taxed as adults.
• The trustee has discretion over who is allocated the income from the trust. This distribution can be altered each year to get the best tax outcome. Like any discretionary trust the range of beneficiaries generally include relatives of the nominated beneficiary and charities.
• Capital gains and franked dividends can be streamed to a particular beneficiary.
• The corpus (capital) of the trust is protected from the financial affairs of the beneficiaries. For example, if a beneficiary becomes bankrupt, the beneficiary’s share of the estate is protected and cannot be accessed to meet the liabilities of the bankrupt beneficiary.
• The testamentary trust can contain restrictions to prevent access to the capital by beneficiaries who might be tempted to spend their inheritance without proper care.
• A testamentary trust can ensure that the deceased assets are held for the children of the deceased and are not at risk if the surviving spouse remarries.
• A testamentary trust can be set up to provide for the needs of a disabled beneficiary.

The Trustee

The control of a testamentary trust is directed by the Will of the deceased. The trustee can be an individual or a private trustee company. The actions of the trustee can also be limited by the Will, for example the trustee may be directed to invest or spend funds in a particular way.

Alternatively, the trustee may be given discretion to act without specific restrictions, as long as the purposes of the trust are being met. In all cases, it is important that a trustee is chosen who will act in the best interests of the beneficiaries and according to the intended purpose.

The Trustee can also determine to make capital distributions and may also wind up the trust if it has fulfilled its purpose.

Tax Advantages

The tax advantage of a testamentary trust is demonstrated in the following example.

A husband dies and leaves an estate of $500,000. He is survived by a wife and two children who are each under 18 years of age. The funds are then invested with a 5% return in the 2014 financial year. This gives an income of $25,000 in that year.

If the wife had received the full amount and invested it in her own name, her tax bill would be $8,500, assuming a 34% marginal tax rate including Medicare levy (because she has salary income).

If a testamentary trust had been used, the income could have been split between the non-working children, but taxed at adult tax rates. Since the amounts would be within the tax-free threshold, the tax liability would be nil. This represents a potential tax saving of $8,500 a year.

The actual tax benefit will depend on the number of family members, particularly children under 18, and the size and structure of the estate.

Altering your Will

If you wish to alter your Will to enable a testamentary trust to be established, you will need to contact a legal advisor. Saward Dawson can work with your legal advisor to determine the tax implications of altering your Will.