What is Testamentary Trust and should you use one as part of your succession plan in Australia?

Estate and succession planning can be a crucial consideration at varying stages of your life as it plays an important role when you are starting a family, a business or where your personal, family or financial circumstances change.

As you start thinking about protecting your wealth and provide for the ones you most care about, it is always helpful to plan through the lens of asset protection and tax consequences in the hands of the beneficiaries of your estate.

Proper and careful estate planning can help reduce capital gains tax, stamp duty and other taxes that may arise upon distribution of your estate to your beneficiaries and also protect your assets from creditors, predators and the like.

One of the most powerful modern estate planning strategy is the use of a testamentary trust in your Will.

What is a testamentary trust?

Simply put, a testamentary trust is a trust established under the terms of a Will. Testamentary trusts commonly take the form of a discretionary trust, however, unlike inter vivos discretionary trusts – which are used to transfer assets and gifts during one’s lifetime, testamentary trusts are activated only upon the passing of the Will-maker.

There are different types of testamentary trusts that can be established and each primary/principal beneficiary under your Will can have a testamentary trust that is most suitable to the circumstances of that particular beneficiary.

Some common types of testamentary trusts established under a Will are as follows:

  1. Beneficiary controlled testamentary trust

As the name suggests, the beneficiary of a beneficiary controlled testamentary trust is provided with an option to use a discretionary trust structure that he or she controls to receive his or her inheritance. This structure is commonly used as a substitute for an outright gift by making use of discretionary trust structure to enhance asset protection and tax liability.

  1. Capital reserved testamentary trust

Under this structure, executors control the trust as opposed to the beneficiary and is commonly used to protect the capital assets in the estate (such as the family home) for an intended beneficiary who is vulnerable because of age or capacity.

  1. Protective testamentary trust

Protective trusts are commonly established for vulnerable family members (such as beneficiaries suffering from a disability), and can be an ‘all needs protective trust’ and/or a ‘special disability trust’ depending on the specific requirements and circumstances of the vulnerable beneficiary.

Key benefits of testamentary trusts

One of the key benefits of a testamentary trust structure as opposed to an outright gift under your Will is that it offers the beneficiaries the opportunity to allocate (or split) the income they receive from the inherited assets amongst the wide range of beneficiaries such as their spouse, children, relatives and charities.  This allows the beneficiary to manage his or her tax affairs effectively amongst the family members and related entities similarly to an inter vivos discretionary trust.

Another advantage of using a testamentary trust is that minor beneficiaries under a testamentary trust are taxed in their own hands as adult marginal tax rates unlike an inter vivos discretionary trust, where such distributions are considered ‘unearned income’ for minors and distributions above a nominal reduced tax-free threshold are taxed at penalty rates.

Inheritance held in testamentary trusts are considered ‘trust assets’ and as such provides certain asset protection to the beneficiaries, in particular, assets held in the testamentary trusts are protected from assets being lost through bankruptcy of the beneficiary. Testamentary trusts also offer an enhanced, but not absolute, level of family law asset protection for a primary beneficiary. While a testamentary trust will normally be considered a resource of the primary beneficiary for family law purposes, it is rare for an Australian Family Court to order the division of a testamentary trust between the parties to a domestic relationship.

When should a testamentary trust be used?

A testamentary trust is best used where the testator wants to create a structure which will give each member of the family an option of entering into a trust structure, which can provide the beneficiaries a means to reduce the impact of tax, and to gain asset protection specific to their circumstances.

A testamentary trust may not the best strategy if there are no family interests to protect, for instance where the whole estate is to go to a charity.

If you would like to discuss whether a testamentary trust structure is appropriate for you, then please feel free to contact:-

Michael Bishop, Partner, 

or Peter Azam 

Pointon Partners with offices in Melbourne and Sydney, Australia 

Michael Bishop

Pointon Partners

+61 3 961 47707