What is a Testamentary Trust?
A testamentary trust is a trust established by a Will and is funded by the will maker's estate. It can also be funded from death benefits payable to the will maker's estate under a superannuation fund or from life insurance funds or any combination of these and the will maker's estate. It is administered by the executor of the will or a trustee appointed in accordance with the relevant provisions of the will.
A testamentary trust can take various forms for example it can be discretionary (i.e. the trustee determines who will benefit) or fixed (i.e. established for the benefit of specific beneficiaries) or a combination of these.
A testamentary trust enables the will maker to leave all or part of his or her assets to the trustee of a testamentary trust, instead of leaving them directly to a nominated beneficiary or beneficiaries. If the testamentary trust is a discretionary trust the trustee has wide discretionary powers in respect of those assets.
Typical Discretionary Testamentary Trust
Will Maker Trustee can be a corporation or individual.
Executor or/Trustee Executor can also be the Trustee and Primary
Beneficiary of the Trust.
Trustee determines which beneficiaries receive
the income and assets of the Trust.
Trust Fund Comprises all or part of the personal or real
estate assets of the Will Maker and the income
from such assets.
Beneficiaries ▪ The spouse of the will maker as the Primary Beneficiary
▪ Family of Prime Beneficiary which may include spouses of
Primary Beneficiary’s children and grandchildren
▪ Related Companies/Trusts
▪ Charities/Religious Bodies
Should you have a Testamentary Trust ?
A testamentary trust can provide a number of benefits for beneficiaries in the form of:
- effective income tax savings;
- asset protection from bankruptcy and family law claims; and
- provide for the maintenance, care and education of any person who is vulnerable because of age, intellectual or physical disability or who is otherwise incapable of managing his or her affairs.
Because of the duration of the trust (potentially 80 years from the will maker's death) it can also provide asset protection, flexibility and tax benefits for successive generations of beneficiaries.
These benefits are generally not available to beneficiaries under a standard Will where assets are distributed when beneficiaries become adults.
An important consideration in establishing a testamentary trust is whether the will maker's estate can support the costs of administering the trust and whether the savings to the estate, derived from the trust, will exceed the costs of administering the trust.
What provisions should be incorporated in a testamentary trust?
The trust should be drafted in such a way as to provide the executor/trustee with power to:
1. determine what assets will be held in the trust;
2. determine when the trust will be wound up; or
3. pass the control of the trust in accordance with the primary beneficiary's Will.
There are a number of reasons for incorporating these provisions in the trust. For example if you transfer certain assets to the trust they may trigger Capital Gains Tax liabilities when the trust is wound up or the circumstances of the beneficiaries may change between the date the will is made and the death of the will maker or the will maker may loose the capacity through unsoundness of mind, to redo his or her will.
Some examples of benefits
If the trustee of the testamentary trust is given complete discretion to determine who receives the income of the trust, Tax is paid on the income of the trust at the marginal tax rate of the beneficiary(ies) who receive it.. Therefore, by selecting beneficiaries on low marginal tax rates, the trustee can minimise the taxation liability. The trustee can choose to distribute income to minor beneficiaries of the trust with each beneficiary being able to receive $6,000 of income tax-free. Each child under 18 receiving income under a testamentary trust is entitled to the adult tax free threshold. This enables the trustee to financially support children on a pre-tax basis rather than an after-tax basis.
The trustee of a testamentary trust can also distribute income from the trust to charitable and religious beneficiaries. As many such beneficiaries have tax deductibility status or are tax exempt, no tax is paid on allocations to such organisations.
- Capital gains tax savings
Capital Gains Tax is triggered on the disposal of an asset. When an asset passes to a beneficiary under a will or to the executor or the trustee of a testamentary trust this does not constitute a disposal for tax purposes. There is no Capital Gains Tax when an asset is transferred from the trustee of a testamentary trust to a beneficiary.
The liability for Capital Gains Tax is triggered when the beneficiary who has received the asset subsequently disposes of it. The trustee can by transferring the asset to a beneficiary on a low or nil income reduce the Capital Gains Tax liability. Also by holding the assets of an estate within a trust presents the beneficiaries with an opportunity to defer the need for the sale of assets (and therefore Capital Gains Tax).
- Bankruptcy and family law claims
If assets are held within a discretionary testamentary trust they do not become the property of the beneficiary until such time as the trustee transfers them to the beneficiary. As the law now stands the trustee in Bankruptcy or any creditor of the beneficiary cannot charge or seize the assets whilst held within the trust. Similarly and for the same reasons the assets so held may receive some protection from property claims under family law proceedings.
Summary
A testamentary trust can provide flexibility for beneficiaries, asset protection, income tax and Capital Gains Tax benefits and the opportunity to defer the vesting of assets.
For more information contact David Buda on (02) 9018 6407 or dbuda@rbhm.com.au
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