Testamentary Discretionary Trusts

What is a testamentary trust ?
A testamentary trust is simply a trust either created in a Will or with money or other assets that came from a deceased estate.

A testamentary trust can take many forms but a common one is where money or other assets are left to a trustee to hold on trust and make discretionary distributions to the spouse, children and grandchildren of the Will maker. In many respects, these types of testamentary trusts are not unlike family trusts.

When should I consider using a testamentary trust ?
Testamentary trusts can be used in a number of situations, including where:

* you have beneficiaries under 18 years of age to whom you want to distribute income in a tax effective manner (see ‘How does a testamentary trust save tax?’);

* you want to set aside money to provide for the education and upbringing of your children or grandchildren;

* you want to leave a gift to a beneficiary who is intellectually challenged or who is not able to look after their own affairs and you want someone else manage it for them;

* you want to leave a gift to a beneficiary who has financial problems (eg a bankrupt, spendthrift or someone suffering a drug or gambling problem) and you want someone else to manage it for them so that they don’t waste it.

What are the advantages of a testamentary trust ?
One of the major advantages of testamentary trusts is how income distributed to children is taxed.

Ordinarily, if someone under 18 receives “unearned income” (such as distributions from a family trust), they are subject to a tax-free threshold of only $416 and will pay high rates of tax (up to 66% on some portions of the income) above that level. However, income received by someone under 18 from a testamentary trust is subject to the normal adult tax free threshold of $6,000 and normal adult marginal tax rates above that level. By taking advantage of the higher tax free thresholds and lower marginal rates applicable to income earned by children from testamentary trusts, significant tax savings can be achieved (see ‘How does a testamentary trust save tax?’). Those tax savings, however, do have to be weighed against the disadvantages of a testamentary trust (see ‘What are the disadvantages of a testamentary trust?’)

Testamentary trusts can also offer some benefits in terms of asset protection and for looking after beneficiaries with special needs, such as those who are intellectually challenged, bankrupt, spendthrift or have issues with drugs or gambling.

What are the disadvantages of a testamentary trust ?
The main disadvantage with testamentary trusts is the administration involved, both in terms of time and cost.

A testamentary trust might last for many years, even after the deceased estate has otherwise been fully administered. You will need to have someone you have faith in to act as trustee of the trust throughout that period (this may, but need not, be the executor of your Will or it could be a child administering the trust for the benefit of themselves, their spouse and their children – ie your grandchildren). The trustee of a testamentary trust will have to keep proper accounts for the trust and file tax returns every year. The costs of doing this eat into the tax savings that can be achieved. Also, Wills with testamentary trusts are much more complex and costly to prepare than standard Wills.

For these reasons, a testamentary trust is not for everyone. A financial planner will be able to advise you whether a testamentary trust makes sense for you. Alternatively, you should speak to your accountant or tax adviser on this topic.

Testamentary trusts need to be carefully structured to ensure they meet your objectives and cater for your individual circumstances

How does a testamentary trust save tax ?
Consider this simple example:

Mary has two children. Each of her children is currently paying the top marginal tax rate (including Medicare levy) of 48.5%. Each of her children in turn has 2 school age children who are attending private schools. Suppose Mary’s estate, if invested, would generate $24,000 per year in income. If that income was received by her children, they would pay $11,640 in tax each year. If instead she puts her estate into a testamentary trust and the trust income is distributed equally to her grandchildren and applied towards their school fees, no tax would be payable – a saving of $11,640 per annum.

The tax savings that can be achieved by using a testamentary trust will depend on the individual circumstances of the Will maker and their family members. In particular, it will depend on how many minor children, grandchildren or other beneficiaries they have and want to benefit.

I want to set up a fund for the benefit of an infant. How should I best do this ?
The best way to do this would be to set up a testamentary trust. The executor or another nominated trustee would hold your gift on trust for the infant in question and apply any income received and perhaps even some of the capital for their benefit (eg paying their living, educational and medical expenses). They would then transfer the fund, or what is left of it, to the infant upon them turning a given age (say 25 years old). There may also be taxation advantages in using a testamentary trust in this way.

Testamentary trusts need to be carefully structured to ensure they meet your objectives and cater for your individual circumstances.

For more on testamentary trusts, see:

‘What is a testamentary trust?

When should I consider using a testamentary trust?

What are the advantages and disadvantages?’

I want to leave a gift to someone who is mentally incapacitated or who is not able to look after their own affairs. How should I best do this ?
The best way to do this would be to set up a testamentary trust. The executor or another nominated trustee would hold the gift on trust for the beneficiary in question and apply any income received and perhaps even some of the capital for their benefit (eg paying their living or medical expenses).

Testamentary trusts need to be carefully structured to ensure they meet your objectives and cater for your individual circumstances.

For more on testamentary trusts, see:

‘What is a testamentary trust?

When should I consider using a testamentary trust?

What are the advantages and disadvantages?’

I want to leave a gift to someone who has problems looking after money and I want to make sure that they don’t squander it. How should I best do this ?
The best way to do this would be to set up a testamentary trust. The executor or another nominated trustee would hold the gift on trust for the beneficiary in question and make payments to the beneficiary in their discretion or as you direct in your Will.

If you are concerned that the beneficiary might become bankrupt and don’t want the money or investments you leave them used to pay off their creditors, you can also set up a so-called “protective trust”. Their interest in the trust property would terminate and be paid over to other beneficiaries if they become bankrupt or tried to subject their interest to a charge. However there are limitations on what you can do with a protective trust.

Testamentary and protective trusts need to be carefully structured to ensure they meet your objectives and cater for your individual circumstances.

For more on testamentary trusts, see:

‘What is a testamentary trust?

When should I consider using a testamentary trust?

What are the advantages and disadvantages?’

What would it cost for James Legal Consultants to prepare a Will with a testamentary trust ?
Testamentary trusts need to be carefully structured to ensure they meet your objectives and cater for your individual circumstances.

Clients of our estate planning service will have a personal consultation with a lawyer to discuss their estate planning needs. Their first consultation is free of charge and on a ‘no obligation’ basis. At their first consultation, we provide a fixed price quote to prepare their Will (and any other documents they may need, such as Enduring Power of Attorney), based on an assessment of the work involved.

For professional assistance with Enforcement of Agreements, please contact James Legal Consultants using the Contact Us link above.