Why have a testamentary trust?

What is a testamentary trust will and do I need one?

What is a testamentary trust will and do I need one?

You’ve worked hard to build your wealth, and don’t want the assets to go to the tax man, or be collected by your beneficiaries’ creditors.

Why have a testamentary trust in a will?

You can spend a lifetime building an estate, so it is only natural that you should be concerned about what might happen both to it and to those who inherit the estate when you are gone. You may be concerned that beneficiaries of the estate could become bankrupt, or divorce, or in some way squander the family wealth. There may be personal problems or addictions such as drugs, gambling or simply bad money management skills.

You might want to ensure that if you die before your spouse and they remarry, the family’s wealth will pass to your children upon that person’s death, and not to someone else’s family. You may want to ensure that any children incapable of looking after themselves are cared for financially. Or you may want to provide for your grandchildren’s education. In each of these circumstances, a testamentary trust can provide some protection and peace of mind.

A testamentary trust is created within and by your Will, but does not take effect until your death. The primary purpose of a testamentary trust is to manage estate assets on behalf of the beneficiaries to whom distributions of income and capital can be made.

Discretionary and non-discretionary trusts

Testamentary trusts come in many varied forms. They can be either fixed (where the trustee has no discretion as to who receives the net income and capital of the trust), or discretionary (where the trustee has absolute discretion in distributing income and capital between beneficiaries). It is also possible to have a combination of fixed and discretionary, where the trustee is given limited discretion.

Testamentary Trust Tax advantages

A testamentary trust functions in a similar way to a discretionary family trust, with certain provisions of the will operating like a trust deed.

Like any trust, a trustee of a well-governed testamentary trust will:

  • Properly understand the tax profile of potential beneficiaries in the light of intended tax outcomes;
  • Lodge a tax return for every financial year that it is in existence;
  • Maintain proper trust account records (such as trustee resolutions, detailed financial statements and reconciliations), especially where a trustee is streaming capital gains or franked dividends; and
  • Fully document capital gains tax events, cost bases, and rollovers and other concessions claimed.

Depending on who is appointed as the trustee and appointor of the testamentary trust, there may need to be a high level of co-operation between family members to ensure that necessary tax, financial and other information is shared for the trust to operate effectively.

A well governed testamentary trust will ensure that tax outcomes are achieved and, more importantly, complex family or legal disputes can be prevented.

Capital gains tax

Special capital gains tax (CGT) rules apply to the transfer of any CGT assets from a deceased estate. You should seek specialist advice in relation to the CGT implications of passing on or disposing of the assets of a deceased estate, noting that current rules may change after your death.  Your trustee appointed will have to keep complete records of CGT assets. These will be needed by the executor and any beneficiary who receives a CGT asset from the estate.

Income tax*

*figures taken from past example and may not apply with current tax rates

Generally it is not tax effective to split income between children due to the penalty tax rates that apply. For example under tax laws children may only allowed to receive $1667 tax free per annum on unearned income, including the low income tax rebate of $750. Anything above this can be taxed at 66 per cent. However testamentary trusts can provide some tax advantages.  Distributions from the trust will be treated as ordinary income, allowing up to $11,000 of tax free income, including $6000 tax free threshold and $750 low income tax offset to be paid to children less than 18 years of age. Of course, for the ordinary tax rates to apply, the primary purpose for establishing the testamentary trust must be for the benefit of the child, and not as a means of avoiding the higher tax rates. Other tax advantages of testamentary trusts include managing capital gains tax liabilities and stamp duty.

Current income tax thresholds for 2016/2017

Taxable Income          Tax on this income

$0 – $18,200   Nil tax payable

$18,201 – $37,000      19c for each $1 over $18,200

$37,001 – $87,000      $3,572 plus 32.5c for each $1 over $37,000

$87,001 – $180,000    $19,822 plus 37c for each $1 over $87,000

Government benefits and disability pensions

Testamentary trusts can also ensure that a vulnerable beneficiary, such as a handicapped child, remains eligible for any government income support while still allowing the trustee to provide for any additional needs.

Disadvantages of establishing a testamentary trust in your will

There will be ongoing administrative costs involved in maintaining the trust after your death, such as accountancy fees and financial planning fees. However, these are generally not significant.

All earnings from the trust’s investments must be distributed to avoid being taxed at the top marginal rate. On top of this, there are some costs for maintaining the testamentary trust, including annual reporting and tax returns.

There is also the potential for family arguments about distributions and the running of the trust. This makes the choice of trustee vital. It is a good idea to appoint an independent trustee to act as sole or co-trustee. Doing do will also ensure the separation of control and benefit of trust assets is maintained, keeping the assets out of reach of creditors but available to family members.  Be aware however if you appoint a professional to do this on your behalf such as an accountant or lawyer they may decline to do it unless they will be compensated financially for their time and effort to run and manage the trust.

How much does a testamentary trust cost?

Whether a testamentary trust is appropriate will depend on each individual’s circumstances and how you want to leave their assets. Their flexibility and asset protection benefits – not to mention significant tax advantages – make them worthy of consideration.

Sometimes a basic will with a few extra changes will have the effect of the intention you want without going to the expense of a full testamentary trust will which can be as much as 5 times the cost of an ordinary will.

The average cost for a basic will these days varies from $200 to $500.  For a full testamentary trust depending on complexities and number of devises and gifts and trust instructions the costs could be from $1,200 to $4,300.

Testamentary trusts in action*

*figures taken from past example and may not apply with current tax rates(the percentages and amounts stated are for hypothetical use as a past example and may not reflect the current tax thresholds- consult a qualified accountant to check what the current thresholds are.

Mary, 71, has three children and nine grandchildren. Her estate is worth $1.35m and her will provides for this amount to be paid in equal portions to her three children ($450,000 each). If each child invests the funds in their own name, they will be subject to tax at their marginal rate. Instead, she sets up testamentary discretionary trusts for each of her children and the grandchildren are nominated as beneficiaries if the trust. If we assume the trust investment earns 5 per cent income, then taking advantage of each grandchildren’s $6000 tax-fee threshold and the low income tax offset, the total tax payable ca be reduced to zero This is an annual tax saving of $21,262.50.    With current tax rates it would be much more.

What about the current family trust I have now already?

The assets of your existing trust do not automatically form part of your decease estate. If all of your assets are presently owned by your trust, there may be no point in establishing a testamentary trust in your will unless you plan to wind down your existing trust or the trust owes you a significant amount.

However, if it is likely your deceased estate will have substantial assets apart from those in your existing trust there may still be advantages in establishing a testamentary trust in your will.

Summary of the purposes of testamentary trusts in wills

Gives the beneficiaries you want in your will to be able to:

  • Asset protection: keeps assets owned by the trust where they are protected from creditors rather than being the individual property of beneficiaries who may be at risk of bankruptcy; and
  • Income distribution– for giving out over a period of time to beneficiaries as you see fit; and
  • Tax benefits to beneficiaries: Income Tax Assessment Act – taxing of beneficiaries under Section 102AG on income received from the trust may be better than situations where there is no testamentary trust and you are passing on investments as part of the inheritance.

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