Testamentary trusts – what they are and why they are effective in estate planning

Testamentary trusts can be very effective estate planning tools to assist in providing for
spouses, children and grandchildren, and are becoming increasingly popular as more
people become aware of their advantages.
A Testamentary Trust is any trust established under a will, but the term is usually used in
the context of a discretionary family trust established under a will.
Why are they becoming more popular?
Their increasing popularity arises from the very considerable benefits that can flow from
their establishment and use, including the fact that although assets of the trust may be
controlled by the intended beneficiary, they do not form part of that beneficiary’s estate.
Major benefits of a testamentary trust include the ability to protect assets and to possibly
reduce tax paid by the beneficiaries from income earned from their inheritance –
providing a greater level of flexibility and control over the distribution of assets to
Reasons why you should consider a testamentary trust include:
CGT benefits
Assets owned by the deceased that would have been subject to capital gains tax (CGT)
had the deceased sold them before their death, can pass through their estate to a
testamentary trust without a CGT event occurring.
If an asset was a pre-CGT asset, the trust will receive a cost base equivalent to the
market value of the asset at the date of death. If the asset is a post CGT asset, then the
trust will inherit the deceased’s cost base. This is particularly important where the assets
have significant unrealised capital gains. This also provides a good opportunity to “reset”
the ownership of assets subject to CGT.
If for example, mum and dad own the shares in a company that is the corporate
beneficiary of their family trust. The shares may have a nominal cost base but because
of trust distributions made over a number of years (and often not paid in cash) the
company may have become very valuable. All of that increased value is potentially
subject to CGT if mum or dad changed the ownership of these shares during their
lifetime. However, after their death the shares can be moved to a testamentary trust and
dividends from the company can then be distributed by the trust to a range of
beneficiaries, tax effectively.
In addition, trust assets may be transferred to beneficiaries without incurring CGT (but
only in respect of assets of the trust that were owned by the deceased when they died).
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Income Tax advantages
Income can be distributed from a testamentary trust to infant beneficiaries (under the
age of 18) and taxed in those children’s hands at adult marginal tax rates (instead of at
the top marginal tax rate as would otherwise be the case). Testamentary trusts may,
over time, sell and replace the original assets received from the estate and the
distributions to infant beneficiaries will continue to be taxed at (more beneficial) adult
With the tax free threshold of $18,200 since 2013/14, testamentary trusts are even
better vehicles for clients because children and grandchildren under the age of 18 years
who receive income from a testamentary trust are taxed on that income at adult rates,
and enjoy a tax free threshold of $18,200 (or $20,542 if the low income tax offset
applies) and the marginal tax rates which apply to adults.
Without this special provision trust distributions to minors may only access a tax free
threshold of $416 and thereafter the effective tax rate applied to the minor’s income is
66% of income up to $1,307 and 45% after $1,308, on the entire amount of income
Flexibility to the Trustee
The trustee can buy and sell underlying assets of the trust (and thereby enhance the
value of the trust) without losing or endangering any tax advantage.
We suggest it is desirable that clients provide the trustee with some guidelines about the
administration of the trust, but they should be carefully framed in order to avoid any
confusion or legal or accounting complications.
Protection of assets
Testamentary trusts provide a level of protection to the assets held in the trust, including
against creditors of the beneficiaries who may want to recover from the trust assets an
amount owing to them by a beneficiary, and in the Family Law Court in the case of the
divorce of a trust beneficiary.
It is quite common for a wife to guarantee her husband’s business venture and vice
versa, to some extent we can all be at risk whether in high risk occupations or not.
However, if a bankrupt has received an inheritance through a testamentary trust it will be
protected from creditors.
In the Family Court, an inheritance held within a testamentary trust is unlikely to be the
subject of a Family Court order in the case of a marriage break-up.
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Protecting ’at risk’ beneficiaries
It is not uncommon for people suffering a variety of disabilities to be unable to properly
manage their financial affairs. At the same time, families may wish to ensure that an
adequate fund is set up to meet the beneficiaries’ reasonable needs, and so as not to
affect any pension rights they may have.
These people can be described as being ’at risk’, a description that may for example
include people who are drug or gambling addicted, mentally or physically disabled or
simply spendthrifts who are not capable of looking after any wealth that is left to
them. For these people a testamentary trust can be managed by a trustee (who should
be) a responsible and capable person (or people) who take action for the benefit of the
’at risk’ person.
It is becoming much more common to steer away from the traditional husband and wife
will, which provides for a husband and wife giving everything to each other and then to
the children, and to replace this with one or more testamentary trusts controlled by the
surviving spouse and/or children under which the spouse and children are potential
If the funds in the estate justify it (and remember this may include the proceeds of life
insurance policies, or superannuation), wills providing for testamentary trusts can
provide that on the death of the spouse, sub-trusts come into existence for the benefit of
each child and that child’s family – controlled by the child concerned.
Testamentary trusts are a very powerful and useful estate planning tool. The flexibility of
such trusts, especially if combined with a memorandum of wishes as to how the trust
should be administered, can be an appropriate arrangement as well as providing a
highly advantageous tax mechanism, for many years into the future.
To find out more about how testamentary trusts can benefit you, contact us on 02 9191
9293 or email mail@rnlegal.org