Testamentary Trust

Daniel Brown

Financial ExpertUpdated on January 11, 2022

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Are you confident that you have planned ahead and taken the right steps to protect and structure your accumulated wealth for the next generations?  A testamentary trust can be an effective way of securing the financial future for yourself and your beneficiaries. 

When it comes to planning for the future, it is imperative to consider your retirement fund and the trust that you’ll be leaving behind after you pass on. For this reason, financial planning is crucial so you can create a plan that will help guide you through building a secure retirement and trust fund that will benefit you and your beneficiaries. 

Although money matters can be extremely complicated, it is still important that you’re aware of the different trusts available so you can have a secure financial future for yourself and your beneficiaries. With that being said, let’s dive into what a testamentary trust is. 

In this article, we’ll share with you everything you need to know about a testamentary trust fund—how it works, its pros and cons, how to create one and more. Let’s take a look!

What is a Testamentary Trust?

A testamentary trust is a type of trust established by a comprehensive Will, including the required testamentary trust terms and legal provisions. In addition, a trust can only be established for the beneficiaries when the Will owner dies. 

What is a Testamentary Trust Used For?

Firstly, the testamentary fund is meant to remove the need for a beneficiary to own an inheritance under their name. 

This protects their inheritance from other parties, like a beneficiary’s divorce, a business failure, bankruptcy, and even a de facto breakup. Another is that a testamentary trust offers opportunities for beneficiaries to reduce ongoing income tax and capital gains tax. 

Testamentary trusts are gaining popularity everywhere since they effectively protect inherited wealth without being expensive. So if a beneficiary is experiencing financial and relationship difficulties, a testamentary trust can help solidify a Will.

So if you’re looking for a way to maximise and protect your beneficiaries’ inheritance in the long run, it is important to establish a testamentary trust. 

How Do Testamentary Trusts Work?

Testamentary trusts are written into a complete testamentary trust. This will wait to be established by an executor for the beneficiaries after the individual’s death. With that said, it’s crucial to seek professional financial advice on this matter to understand how a testamentary trust should be established and used. 

After your death, your executor will use your Will to establish the testamentary trust for your beneficiaries. The beneficiary will then name their testamentary trust and will receive a tax file number for their trust. 

After this process, beneficiaries can still manage and invest their inheritance as they would. However, you should note that their name does not own their inheritance; instead, these are “held on trust” for the advantage of each beneficiary. 

Because of this, beneficiaries can protect their inheritance from third-party threats, allowing you to minimise ongoing income tax and capital gains as well, all of which could impact your testamentary trust. 

However, you should know that testamentary trusts aren’t all the same and would depend on the provisions of your Will.

When is a Testamentary Trust Useful?

Before diving into the pros and cons of a testamentary fund, it’s crucial to know the different conditions where having a testamentary fund is useful.

  • High-Risk Beneficiaries: If one of your beneficiaries is in a high-risk profession or owns a business with a high probability of negligence claim, getting a testamentary trust is a must.
  • Credit Protection: Fortunately, testamentary funds can protect your beneficiaries from creditors. Also, this trust ensures that their inheritance is not susceptible to their partner’s business debts.
  • Education: If you want to leave money for schooling, a testamentary trust is a tax-effective way to achieve this.
  • Divorce of a Child: Since an asset held in a trust is an asset that doesn’t belong to any individual, the family court can’t make an order that would require a redistribution of funds. This is why it’s an effective way to ensure your divorced child receives their inheritance.
  • Remarriage of Spouse: A testamentary trust ensures that if their surviving spouse remarries; their trust won’t be diverted to the new family.
  • Children with Issues: If you have a child that tends gambling, drug addiction, or one who is a spendthrift, a trust ensures that their share is kept intact.
  • Disabled Children: If you have a disabled or intellectually impaired child, your estate can be an effective tool to manage their well-being. 

The Pros and Cons of a Testamentary Trust 

Pros

  • The great thing about having a testamentary trust is that the capital gains, income, and franked dividends would be distributed among your beneficiaries in a tax-efficient way. This is because trusts don’t have to pay income tax, allowing your beneficiaries to enjoy your estate. However, you should know that beneficiaries will need to pay tax from undistributed income.
  • If some of your beneficiaries are eligible for a pension, there are some gains that you get from providing a testamentary fund. Assets of a testamentary trust are not accounted for when pension eligibility is established. Because of this, they will receive the same amount, despite receiving distributions from your estate.
  • Usually, you won’t get any tax due when you transfer your assets to your executor and your testamentary trust. Besides that, there shouldn’t be any tax on the cash proceeds as well for your life insurance or super death benefit. 

Cons

  • Tax implications may arise when your residence is held in the testamentary fund; that is why it’s best to speak to your financial adviser regarding this issue.
  • If you want to appoint a professional to be the trustee of your testamentary trust, know that there will be some fees involved. These fees may include accountancy and tax preparation fees, which could ultimately reduce the value of your assets. 

Testamentary Trust and Wills

When you’re maintaining a trust, know that there will be an ongoing administrative cost, like accountancy fees to prepare for your trust taxation returns. Additionally, you will need to consider the amount of income generated by your estate and if it will be sufficient to warrant a testamentary trust. 

With that, your financial advisor will need to check if you have enough assets in your estate and whether they can apply to one or more of your intended beneficiaries. 

Testamentary Trusts as Part of Your Estate Plan

High net worth individuals with complex personal and professional affairs will need to know how to best approach long term estate planning. They want to know the best way to transfer and preserve wealth for the next generations of the family. With that said, it’s no surprise that this is one issue regarding their finances that sits at the higher ranks of their priorities list.

As estate wealth comes in significant amounts, it’s only right to take advantage of testamentary funds, especially when its primary advantage is to allow an individual to acquire wealth and exercise control over the wealth distributed among the beneficiaries. 

When it comes to estate planning and testamentary trusts, the latter is well-suited to help blended family situations or concerns with the first generation beneficiary, like insufficient wealth left to the spouse or child. 

In addition, testamentary trusts can also be used to gain tax savings. For example, suppose the income is distributed to a child under 18. In that case, they are subject to a flat tax rate without the gains of tax-free threshold or marginal tax rates.

However, depending on how the trust was established, child beneficiaries may qualify for tax concessions on income received from the trust. As for high net worth individuals, this can equate to considerable tax savings, which could help preserve their wealth for future generations. 

Important Things to Consider About Testamentary Trusts

When it comes to the distribution of trust income, trustees will have total discretion regarding these decisions. With that said, it’s crucial that when you appoint a trustee, they should know the most tax-effective approach to asset and income distribution, especially with minor beneficiaries.

Below are other things to consider when creating a testamentary trust:

  • Non-Arm’s Length Transactions: When appointing a trustee, they must know the limitations on tax benefits that may be imposed when they transfer the assets or income to a non-arm’s length arrangement. With that, they need to ensure that the testamentary trust is structured to avoid various issues.
  • Primary Residence a Part of a Trust: Usually, when establishing a trust, a testator’s primary residence is often a CGT exempt asset. However, issues may arise where the tax exemption may remain established if the primary residence becomes a part of the asset base of the trust.
  • Protection of Assets: An advantage of having testamentary trusts is that you can take action to protect your assets from attacks by creditors of your beneficiaries after your death. 

Seeing as a carefully structured testamentary trust can provide peace of mind, it’s only right that you work with a credible financial planner to assist you with this to ensure that subsequent generations will reap the benefits of your trust. 

How to Create a Testamentary Trust?

A testamentary trust is created by your Will and won’t come until after your death. 

Here, you get to decide how you’d like to distribute your wealth to your beneficiaries, with the discretion of your trustee. 

For your trustee to exercise these duties, they should be able to identify the beneficiaries during distribution. If there is uncertainty regarding the beneficiaries of the trust, then the court will default with a position saying that you’ve died without a will.

In some cases, your family may want to establish a testamentary trust after you die, but they can only do this within three years of your death. 

This allows your trust to be based on your assets and the income to get the same tax advantages as you would with a testamentary trust. However, you should note that the trust that your beneficiaries will create shouldn’t go over the amount they’ve received under the law. 

Your trust can be funded by some or all of your assets and payments made after your death, like a superannuation death benefit or insurance. Additionally, you should know that a testamentary trust can continue for up to 80 years, but it can also vest on an earlier date if the trustee decides. 

Essentially, a testamentary discretionary trust will have a trustee or trustees, discretionary beneficiaries, and sometimes, an appointor who controls the trustee/s. 

The trustee is tasked to determine which beneficiaries will receive income or capital from the testamentary trust and the amount of capital or income they’ll receive. With that, even assets left to children should pass through them. 

When you’re setting up a trust, you set the terms of your testamentary trust in your Will. By doing so, you restrict the ability of beneficiaries to control the investments and activities of the trust, or you can also decide to give them complete control. 

In other cases, you can decide to “rule from the grave” so you can protect inherited assets and that they are used sensibly for the benefit of the primary beneficiary. If you decide to head this route, you must have an independent person controlling your testamentary trust so you can consider all the implications with caution. 

Working with a Credible Financial Expert is Crucial When Creating a Testamentary Trust

There’s no denying that a testamentary trust holds a plethora of complications. But it’s also worth noting that doing so will help protect your wealth and income for the next generations. 

Because of this, it’s important to plan ahead and look at your finances to ensure that you take the right steps in creating an effective testamentary trust that will benefit your beneficiaries in the long run. 

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This is a model, not a prediction. Amounts and repayment periods are estimates only, actual amounts may be higher or lower.

  • It applies to loans where your regular repayment includes both interest and the gradual repayment of the amount borrowed.
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This is a model, not a prediction. Amounts and repayment periods are estimates only, actual amounts may be higher or lower.

  • It applies to loans where your regular repayment includes both interest and the gradual repayment of the amount borrowed.
  • Initial inputs will be displayed on the left hand side of the graph. Your ‘What if’ scenario (if applicable) will be
    displayed on the right hand side of the graph.