Testamentary trusts

A Trust is a legally binding relationship between one person (‘the Testator’, if the trust is created by Will or ‘the Settlor’, if the trust is created during their lifetime) who transfers assets (‘the Trust Fund’) to a person or groups of persons (‘the Trustees’) who then hold the assets for the benefit of an individual or group of individuals (‘the Beneficiaries’)

A ‘Testamentary Trust’ is simply a trust that is created under the terms of a Will hence such structures are also commonly referred to as ‘Will trusts’. Unlike ‘inter vivos’ or lifetime trusts, a Testamentary Trust or Will Trust does not take effect until the Testator has died.

The Trustees would initially be the executors designated within the will but can be changed after the trust is established. The Trustees must administer the Trust Fund in accordance with the powers, provisions and obligations set out in the document creating the trust, e.g. the Testator’s Will or the Settlor’s Trust Deed.

Generally there will also be a person nominated (‘the Appointor’) to oversee particular actions of the Trustees and in some cases, have the power to remove Trustees should they not be carrying out their duties in the correct manner.

The Trust Fund can consist of a wide variety of assets including land, cash, shares or even antiques that formed part of the Testator’s estate.

Generally speaking, the maximum period that a Trust can run for is 80 years but within those parameters a Trust can last for any length of time as the Testator and Trustees see fit, be it during widowhood, until a child marries or a grandchild attains a certain age.

WHY CREATE A TESTAMENTARY TRUST?

A Testamentary Trust creates a structure by which the Trustees can administer the Trust Fund in a flexible manner to deal with a Testator’s particular circumstances.

Common reasons for establishing a Testamentary Trust include:

controlling and protecting family wealth across the generations;
reducing income tax and capital gains tax;
providing a protective, flexible framework for a Beneficiary who is either incapable of managing their own affairs or vulnerable to exploitation;
creating a structure that allows a spouse or partner to benefit during their lifetime whilst ensuring that children (including those from a previous marriage) are financially provided for in the long term;
creating separate Testamentary Trusts for each beneficiary which can then be independently managed and administered;
postponing the entitlement of a young child or adult until they are more mature whilst allowing money to be spent for their benefit in the meantime; and
providing an additional layer of protection for family assets from potential risks of bankruptcy and family breakdown.

TAX ADVANTAGES OF A TESTAMENTARY TRUST?

Tax benefits include:

income can be distributed to Beneficiaries in a way that ensures Beneficiaries (including children) with the lowest tax rates receive the highest amount of income. This is particularly useful if you as Testator are concerned with maximising the net amount of income available to the wider family, say, a surviving spouse and children of that relationship.
for a Testamentary Trust the tax free threshold for each minor Beneficiary is the adult rate of $18,500. This compares with a $416 tax free threshold available to minor Beneficiaries of lifetime discretionary trusts above which penalty tax rates are applied.
specific income and asset types can be paid to specific Beneficiaries, e.g. franked dividends go to those that would be able to get the benefit of the franking credits.
there is no stamp duty on the creation of a Testamentary Trust.
a Testamentary Trust structure may defer the payment of capital gains tax until assets are disposed by the Trustee or Beneficiaries.
if charities, or other tax-exempt entities, are named as Beneficiaries then it is possible to distribute pre-tax income to such Beneficiaries.

WHAT ARE THE DISADVANTAGES?

As with all estate planning matters, not every structure will be suitable for every person. Consideration should be given to your particular needs and circumstances.

In reviewing the options available, some of the commonly discussed disadvantages of Testamentary Trusts (and indeed trusts in general) are as follows:

the cost of establishing a Testamentary Trust is comparable with the combined cost of establishing a lifetime discretionary trust and a Will but the more complex the trust structure, the higher the initial set-up fees (which are not tax deductible).
in addition to the initial set-up fees there will be ongoing, annual accounting together with other professional (e.g. financial advice) and compliance fees.
if the Trustee distributes income to Beneficiaries in order to arrange the most tax effective scenario, some Beneficiaries may inherit more than the Testator would have wished simply because they are in a low tax bracket.
complexity and formality of the structure can be a headache. For example, minutes are required for each Trustee resolution. If the Trustee is not the primary Beneficiary, a Beneficiary must ask a Trustee, if they would like a large distribution for a major purchase because they are not controlling the underlying assets.
since changes to the Social Security rules in 2002 the whole of the assets of a trust can be counted as belonging to a Beneficiary on a pension or other social security means tested benefits.
subject to the terms of the trust, retaining the main residence in a Testamentary Trust may result in a loss of the CGT exemption. Land Tax consequences would also need to be considered.
as with all discretionary structures, much will depend on the decisions taken by the person in ultimate control, in this case the Trustee of the Testamentary Trust. This can be off-putting for certain Testators who prefer certainty over flexibility.

OTHER FACTORS TO CONSIDER BEFORE ENTERING INTO A TRUST ARRANGEMENT

Generally speaking, an estate must have income-generating assets valued in excess of $500,000 for the taxation benefits to be significant. In determining the size of an estate the following issues should be considered:

jointly owned assets do not form part of the Testator’s estate as they will pass by survivorship and not through the Testator’s Will;
where you have nominated a beneficiary under a life insurance policy, the proceeds will be paid to that person directly and will not form part of the Testator’s estate;
death benefits from a superannuation fund do not automatically form part of the member’s estate. The Trustee of the superannuation fund generally has a discretion whether to pay the benefits to the member’s estate or directly to the member’s dependents subject to any binding death nomination made by the member;
assets that are already held in a lifetime discretionary trust do not form part of the Testator’s estate.

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