Testamentary Trusts – Benefits and Pitfalls
When it comes to estate and succession planning, people often consider a Will in solitude as the only way to provide for their loved ones. Structures such as testamentary trusts offer significant tax and saving benefits to ensure loved ones are best provided for under a Will. In this article, our commercial and succession law teams consider the availability and functions of testamentary trusts as well as the benefits and pitfalls of this unique type of structure.
TESTAMENTARY TRUSTS – FUNCTION AND CREATION:
A testamentary trust is, at its simplest, established under a valid Will or Codicil. Accordingly, unlike a typical trust, this type only comes into effect upon the death of the person making the Will (‘Testator’).
Upon the death of the Testator, the property and assets of the deceased (‘Estate’) are administered as usual. However, where a testamentary trust is established, part or all of the Estate may be transferred into the trust to be held and distributed by the person appointed to manage the trust (‘Trustee’) for the benefit of the nominated beneficiary or beneficiaries of the trust (‘Beneficiary’).
This type of trust can be fixed (where Beneficiaries’ entitlements are clearly set out) or discretionary (subject to the Trustee’s discretion), but more common than not are discretionary. Typically, testamentary trusts are established for Beneficiaries who are intellectually disabled, are under the age of 18 (i.e. children) or are at risk of family law proceedings or bankruptcy, but they can also be used to protect assets and reduce tax liability.
So, considering the above, why should you choose a testamentary trust, and what are the potential downsides?
BENEFITS OF TESTAMENRARY TRUSTS:
Testamentary trusts provide several significant benefits to not only Beneficiaries but also the Testator. These benefits include:
Control and Flexibility
One of the main incentives for a testamentary trust is that it offers the Testator greater control and flexibility over the assets of the Estate, including how and when they are distributed. This is especially important given the complexity of estate planning and families generally.
A testamentary trust can be established for up to eighty (80) years and can benefit multiple generations, including grandchildren or great-grandchildren. Since this type of trust only comes into existence upon the Testator’s death, it is also considered a revocable trust and can be amended or dissolved at any time during the Testator’s life, just like a Will.
Perhaps the most significant benefit provided by a testamentary trust, aside from the potential tax benefits, is the protection of trust assets in the following situations:
Where a Beneficiary under a Will is experiencing solvency issues or is bankrupt, their inheritance under the Will may be subject to third-party claims and claims by creditors. However, where a testamentary trust is in place, the trust’s assets are protected and do not form part of the Beneficiary’s estate for solvency purposes or bankruptcy proceedings. This is because the trust assets are not held by the Beneficiary but rather by the Trustee on behalf of the Beneficiary under the testamentary trust.
(b) Family Law Proceedings
Similarly, assets held in a testamentary trust may be protected from family law proceedings. However, the Family Law Act 1975 provides certain courts with extensive powers concerning the property of a party to a marriage, and whether a testamentary trust will provide adequate protection from these proceedings may also depend on several other factors.
Should the widowed spouse of the Testator choose to remarry, assets provided to the spouse under the Will may be applied to the new marriage and for the benefit of the new partner and their children (instead of children from the previous marriage) if the spouse were to predecease their new partner. A testamentary trust guarantees that assets held in the trust are only applied to and for the benefit of nominated Beneficiaries.
Another considerable benefit of testamentary trusts is that they allow any income, capital gains, and dividends to be distributed to Beneficiaries in the most tax-efficient and profitable way.
Under the Income Tax Assessment Act 1936, the income of this type of trust is treated as ‘excepted income’, and tax-free thresholds may apply to particular Beneficiaries. For more information on excepted income, see the ATO guide: Click Here
Children and Other Beneficiaries
A testamentary trust is also particularly favourable for the following classes of Beneficiaries:
- Minors and Beneficiaries who lack capacity (i.e. the intellectually disabled); and
- Problem Beneficiaries – those who are irresponsible or may suffer from addiction or other failings that could result in the dissipation of their inheritance.
Instead of a Beneficiary receiving property or assets under a Will, a testamentary trust only provides Beneficiaries with an entitlement to the trust assets. This ensures that the trust assets are protected and not squandered or lost. This also means that the Trustee can distribute assets at a time (e.g. when the child is mature enough) and for specified purposes (e.g. for university or tuition fees only).
Additionally, should a Beneficiary already be or become incapacitated, a testamentary trust can allow for assets to be applied and managed by the Trustee or family to benefit the Beneficiary.
Transfer Duty (‘Duty’) is typically not payable on the creation of the trust or upon the transfer of assets into a testamentary trust. This is provided that the trust is considered a family trust or otherwise exempted from Duty under the Duties Act 2001. Duty may, however, still apply to assets acquired by the Trustee under the trust.
Conversely, testamentary trusts do have some disadvantages and may not be appropriate in all circumstances. Some of these drawbacks are as follows:
Unfortunately, testamentary trusts do not get rid of the need for or circumvent probate. This process, which can take several months, is therefore still required before assets of the Estate can be distributed to Beneficiaries under the Will. Furthermore, the trust will not come into effect until probate is granted by the court.
(b) Costs and Complexity
While a testamentary trust may prove cheaper than creating a living trust, they still cost money to prepare, impose administrative costs associated with the management of the trust and can be just as complex. That said, these costs are not payable upfront, will come out of Estate and given the potential savings associated with testamentary trusts are commonly recoverable.
To gain the most benefit from this type of trust, it is first important to seek financial and accounting advice. This is especially crucial given that it may affect other entitlements and arrangements of Beneficiaries. For instance, if a Beneficiary under the testamentary trust is over 65, care must be taken to ensure their eligibility for the Age Pension is not impacted.
RAMSDEN LAWYERS – IS TESTAMENTARY TRUSTS RIGHT FOR YOU?
As outlined above, testamentary trusts offer a means for those wanting to maximise benefits and minimise tax for their loved ones. They also provide greater flexibility and control and ensure your legacy is adequately protected.
On the other hand, a testamentary trust may not always be suitable depending on a person’s circumstances. To that end, we recommend seeking accounting advice to determine whether a testamentary trust is right for you.
If you are seeking legal advice or assistance with establishing a testamentary trust, Ramsden Lawyers can assist you. We are happy to arrange an obligation-free initial consultation to assist you in navigating the procedures set out under the relevant legislation for your circumstances.
The content of this article is intended to provide general guidance to the subject matter and must not be relied on as legal advice. Specific advice should be sought about your circumstances.