What is a Testamentary Trust?

A Testamentary Trust is a type of discretionary trust that's established in a will. The trustees of each trust can decide which of the nominated beneficiaries may receive the benefit of the distributions from that trust for any given period. The assets are not transferred to the individual beneficiaries directly, but rather to a trustee of the established testamentary trust that holds the assets in the trust fund, for and on behalf of the beneficiaries.

Advantages of Testamentary Trusts

1. Control: A Testamentary Trust can be validly established for up to 80 years, benefiting two to three generations. The distribution of the trust’s income and assets is completely flexible. Testamentary trusts can also be dissolved at any time, and distributions made to the desired beneficiaries.
2. Asset Protection: Testamentary trusts provide a greater degree of asset protection compared to if the assets were held by the beneficiaries in their personal capacity. They are particularly beneficial for intellectually disabled beneficiaries, as well as beneficiaries with illnesses, addiction problems or other weaknesses which could result in the loss or dissipation of an inheritance.
3. Tax Benefits: Under a testamentary trust, children under eighteen are taxed as ordinary taxpayers, commencing at the lower tax rates. This results in considerable reductions in the total tax payable when distributions are made to children and grandchildren.
4. Preservation of Government Benefits: At present, Centrelink does not take assets held by testamentary trusts into account when calculating the pension eligibility of a beneficiary.

Disadvantages of Testamentary Trusts

1. Succession Issues: The trustee essentially controls the trust and has discretion to determine the future of the trust and its assets. The succession of the role of trustee must be specifically spelt out in the Will.
2. Administration Costs: Assets held by a testamentary trust must be sufficient to justify the expense of administering the trust. For example, accounts will need to be prepared and maintained, and a tax return will need to be lodged each year.
3. Capital Gains Tax: If the trust has capital assets that are sold at a loss, those capital losses cannot be distributed to the beneficiaries, and must be carried forward in the trust and set off against future capital gains.
4. Pension Eligibility: If either the primary or another beneficiary is a pensioner, care must be taken to ensure that the beneficiary’s pension eligibility is not jeopardised by their inheritance in the testamentary trust.

Remember, a Will incorporating testamentary trusts will only form part of a total asset and estate plan. The control of family companies and trusts following death, superannuation arrangements, business succession arrangements, enduring powers of attorney, appointment of enduring guardians, and family law considerations should also be considered.