If you plan to leave assets to loved ones upon your passing, you may want to consider incorporating a Testamentary Trust into your Will. But what is a Testamentary Trust exactly?
A flexible, secure and tax-effective way to distribute assets (as well as any capital and income from their sale), a Testamentary Trust empowers a Trustee to manage and distribute assets to beneficiaries as they see fit.
Interested in learning more? To help you understand your estate planning options, our below guide explains what a this type of Trust is, as well as its advantages and potential risks.
What is a Testamentary Trust?
A Testamentary Trust is established in a Will to allow a Trustee to hold and manage its assets on behalf of beneficiaries after the Testator has passed away.
The Trustee must be nominated in the Will, as they will decide which beneficiaries receive distributions and when, as per the Testator’s wishes. In other words, beneficiaries will not receive the assets directly.
There are two widely-used types of Testamentary Trust in Australia:
Discretionary Testamentary Trust
In a Discretionary Testamentary Trust, the beneficiary has a choice to receive some or all of their inheritance through the trust. What’s more, the primary beneficiary is permitted to appoint and remove a Trustee, even being able to appoint themselves to manage their inheritance within the trust instead.
Protective Testamentary Trust
In a Protective Testamentary Trust, the beneficiary is obliged to take their inheritance through the trust and does not have the power to appoint or remove Trustees. This form of trust may be appropriate depending on the beneficiary’s age, ability and behaviour and considering the asset protection goals of the testator.
Who can be a Trustee of a Testamentary Trust?
Anyone who you believe will act in the best interests of your beneficiaries can be a Trustee, including your spouse or the Executor of your Will, provided they have the requisite legal capacity to perform such role.
Who can be a beneficiary of a Testamentary Trust?
The beneficiaries of your Trust will be the same as those detailed in your Will.
Benefits of a Testamentary Trust
Greater control
Testamentary Trusts are highly suited to beneficiaries who may not be able to manage their inheritance independently.
By allowing the Trustee to hold and direct assets, this type of Trust is particularly appropriate if beneficiaries are minors, living with a disability or prone to irresponsible spending.
Flexibility
The Trust’s assets can be distributed with complete flexibility to suit individual requirements, provided the terms set out in the Testator’s Will are met.
A Testamentary Trust can be valid for up to 80 years and dissolved at any time, with distributions being made to the nominated beneficiaries.
Asset protection
If a Will does not include a Testamentary Trust, then the deceased’s assets may be vulnerable to third party action against beneficiaries.
Essentially, the assets in this Trust are held by the Trustee on behalf of the beneficiary, rather than by the beneficiary themselves. A key advantage of this structure is that assets are not accessible to former partners of beneficiaries after marital breakdown or de facto relationship dissolution.
Similarly, these assets are also safeguarded from the beneficiary’s creditors and claimants. As the beneficiary is not technically entitled to the assets until they are distributed by the Trustee, the Trust can prevent any loss of inheritance due to bankruptcy or other financial circumstances.
What’s more, if a beneficiary becomes temporarily incapacitated, their family are permitted to manage the Trust’s assets for their treatment and benefit – instead of giving a government agency control over a portion of the estate.
Tax advantages
Oftentimes, beneficiaries will invest the funds they receive from a Will to generate more income. These earnings are then added to their salary, which they pay tax on at the marginal rate.
With a Testamentary Trust, however, this extra income is distributed to beneficiaries via the Trustee. If beneficiaries pass on these funds to their children who are under the age of eighteen and not working, they can then claim an income tax benefit for each child.
There are also other tax advantages to using a Testamentary Trust. For instance, no Stamp Duty or Capital Gains Tax is charged when paying assets into this Trust because the transfer takes place via the Will.
Capital gains on assets held in this type of Trust can also be distributed tax-effectively. If a beneficiary has earned a low income the year assets are distributed, they may be able to benefit from the five-year averaging rate of Capital Gains Tax losses. As a result, Capital Gains Tax payable on realised assets can be significantly reduced.
Pension eligibility
At the time of writing, Centrelink does not consider inheritance held in a Testamentary Trust when determining the beneficiary’s pension eligibility. That said, any income distributed by the Trust is taxable once given to the beneficiary.
Superannuation and life insurance entitlements
Superannuation proceeds are generally not included in the assets of a deceased estate, which means their distribution is instead determined by fund regulations.
However, a Testator can request that the fund pay their superannuation or death proceeds to the Executor of the Will and on to the Trustee of the Testamentary Trust. In most circumstances, this process is favourable to distributing proceeds directly to the nominated beneficiaries.
Potential risks of a Testamentary Trust
Succession disputes
The Trustee has discretion to determine the future of the Testamentary Trust and its assets. To prevent any unnecessary disputes over these matters, it’s important for a Will to specify the nominated Trustee’s successor.
Trustee disputes
To avoid potential disputes over who gets what and when, Trust administration requires successful cooperation and regular communication between those who may share the role of Trustee.
Administration fees
The Trust will need to hold sufficient assets to warrant the cost of its administration. For instance, accounts must be prepared and managed, with a tax return lodged every year.
Capital losses
If capital assets in a Testamentary Trust are sold at a loss, this loss cannot be distributed to beneficiaries. Instead, it must be transferred to the Trust to set off any future capital gains.
Get tailored support with a Testamentary Trust in WA
Testamentary Trusts can help to distribute your estate in a flexible and tax effective manner, giving you, your Trustee and your beneficiaries peace of mind.
To ensure your intentions are fulfilled as intended and without unnecessary stress, it’s important to seek legal advice from an Estate Planning specialist.
At Affinitas Legal in Perth, our experienced Testamentary Trust lawyers are here to help you navigate the legal complexities of estate administration. Please get in touch with our lawyers for personalised support.
