One of the most loving things that you can do for your family is make plans for what happens after you die. This is particularly important if you have children or vulnerable adults who depend on you financially. A testamentary trust might be the right tool to help you look after those you love.

What is a testamentary trust?

As the name suggests, a testamentary trust is made under a will and begins at the death of the testator (the will-maker). This tool allows you to financially support someone without giving that person direct control of the assets. 

How is a testamentary trust made?

Your solicitor can draft your trust. Before speaking to your solicitor, you should think about what you want to include in the trust (the assets or capital), who you want to benefit from the trust (the beneficiaries), and who you can rely upon to carry out your wishes (the trustee or trustees). 

A common arrangement for parents of young children is to incorporate all assets (including property and superannuation) into a trust for the benefit of their children. In that scenario the trustees might also be nominated as the guardians of the children. 

Who should you choose as a trustee?

The trustee is the legal owner of the assets of the trust, so the most important thing is to ensure that the trustee is reliable and honest. Having more than one trustee can be good insurance against fraud or carelessness. 

In some cases, the size or contents of an estate may justify an expert trustee. A trustee can be a professional (such as an accountant or lawyer) or an organisation (such as the NSW Trustee and Guardian). However, a professional trustee does need to be paid out of the estate. 

What are the advantages of a testamentary trust?

A testamentary trust allows a will maker to control the distribution of their assets for up to 80 years. This lets you look after your children, grandchildren, and even great-grandchildren! There are many advantages to this type of arrangement. 

Protection

A testamentary trust can be very prescriptive. You can set out exactly how your money should be divided between the beneficiaries, when the money is given out, and even what it can be spent on. This can prevent the capital from being frittered away by beneficiaries with mental health conditions or addictions. 

Because the trustee legally owns the assets of a trust, the funds are generally protected from outside claims against the beneficiaries. For instance, the trust is usually not vulnerable during family law litigation (ie the capital in the trust is unlikely to be split in a divorce). Similarly, the capital is generally insulated from bankruptcy, as well as personal injury and professional negligence claims. 

Flexibility

You can choose to make your testamentary trust discretionary. In that case, the trustee has some freedom in distributing the income and capital of the trust. For instance, your trustee may distribute the trust based on the different needs of each child through the years. This allows the trust to evolve over time as circumstances change. 

Minimise Tax and Capital Gains

There are tax benefits from testamentary trusts, which you should discuss with your solicitor and accountant. In short, trustees may be able to distribute from a discretionary trust in tax-effective ways, including taking advantage of five-year averaging for capital gains losses. In addition, under a testamentary trust, minor children receive beneficiary tax rates for income from the trust.

Are there any disadvantages to a testamentary trust?

As with all forms of estate planning, a testamentary trust is not right for everyone. 

The administration of a trust costs money each year that the trust operates. This will include annual tax and auditing costs and could also include the trustee’s professional fees. For this reason, a discretionary trust is not usually the best option for smaller estates. 

A testamentary trust can be challenged by those who wish to receive immediate access to their inheritance. Regardless of whether the claim is successful, the process will cost the estate additional legal fees and may cause family conflict. A testamentary trust always involves a degree of ongoing interaction between the trustee/s and the beneficiary/ies. As with any family dynamic, this can be a source of tension and conflict.

Finally, income from a trust is used when calculating income for Centrelink income support benefits (although currently the assets of a trust are not used to determine eligibility under the asset test).

Conclusion

There are many benefits to using a testamentary trust to protect your loved ones. This form of estate planning allows you to protect your estate against outside claims and ensure that your wealth is used to benefit those you love. There are some disadvantages to choosing a testamentary trust, so it is important to speak to your solicitor and accountant before deciding whether this option is right for you. 

This information is for general purposes only and we recommend you obtain professional advice relevant to your circumstances.

If you or someone you know wants more information or needs legal help or advice, please contact us on 03 8346 4900 or email [email protected].