Most Australians think that a simple will is all your family needs when planning their estate. But there's another (and sometimes better) way to keep wealth and assets safe, avoid paying taxes, and distribute your possessions — pairing your will with a testamentary trust.
In this article, we walk you through testamentary trusts, their importance, and how they give more financial security compared to a standalone will.
We will also look at some of their benefits, including tax savings, asset protection benefits from legal action, and providing for your children.
What is a Testamentary Trust?
A testamentary trust is a specific type of will-based legal arrangement that only comes into effect after the person making the will has passed away. This simply means that the deceased's property, etc., can be put into this type of trust. The trust then holds those assets, which can still be controlled and invested based on the beneficiary's wishes.
People usually use a testamentary trust to enhance a person's estate. It allows for assets to be protected and passed down in a way that is in line with the wishes of the deceased.
Estate Planning and Testamentary Trusts
A testamentary trust is important in estate planning because it offers a systematic approach to distributing money while reducing threats and tax liabilities.
Some key benefits of incorporating a testamentary trust in estate planning include:
- Minimising tax implications and liabilities on the estate.
- Protecting assets for beneficiaries, including children and spouses.
- Enhancing control over the distribution of wealth.
- Complementing other estate planning tools, such as wills and powers of attorney.
Will vs Testamentary Trust: What's the Difference?
To be clear, a testamentary trust isn't a replacement for a will. But it can go hand in hand with it to strengthen your estate planning strategy.
Here's a look at what these two legal instruments do for you when estate planning:
Will
- Specifies how assets are distributed to beneficiaries upon death.
- Beneficiaries receive assets in their personal names.
- Relatively straightforward and less complex than a trust will.
- Can be changed at any time before death.
Testamentary Trust (within a will)
- Offers beneficiaries the option to hold all their bequeathed assets within trust, often providing asset protection, tax benefits, and flexibility in asset distribution.
- Assets are held by a trustee for the benefit of beneficiaries, not directly in their names.
- More complex and requires ongoing management.
- Can be more flexible in how and when beneficiaries receive benefits.
- Can protect assets from creditors or divorce/legal issues.
So to give you a better understanding of how a will and testamentary trust might work, take a look at the comparison below:
A testamentary trust can only be created by a Will. If you die without a Will (i.e. “intestate”), no testamentary trust can spring into existence.
If you want a trust that’s set up during your lifetime (and so doesn’t depend on a Will), you’d need an inter vivos (living) trust, such as a discretionary family trust or a Special Disability Trust established while you’re still alive.
The Tax Benefits of Testamentary Trusts
Why should you use a testamentary trust? Here are some positive tax implications:
- You can distribute your income to beneficiaries (potentially reducing the total tax payable, especially for families).
- When minors receive income, it gets taxed just like it does for adults, which means they can enjoy the full tax-free limit (normally, unearned income for under‑18s is taxed at higher ‘penalty’ rates).
- Unlike some trust funds set up while someone is alive, testamentary trusts don’t face penalty tax rates.
How A Testamentary Trust Can Protect Your Assets
A testamentary trust is one way to safeguard your assets. Some estate assets kept in the trust aren’t inherited directly. That means that you can keep them safe from different financial risks, such as:
- Creditors and bankruptcy claims.
- Legal disputes and family law claims, such as divorce settlements.
- Poor financial management by beneficiaries, ensuring inherited assets are used wisely.
A testamentary trust ensures that wealth is preserved and used for the intended purposes by maintaining control over how you distribute assets.
Are There Government Benefits for Testamentary Trusts?
Beyond enhanced protection, some people use testamentary trusts because of the government benefits. For instance, those receiving testamentary trusts can often continue receiving government assistance, like the Age Pension.
For people with any type of disability, there is also a specific type of testamentary trust called a Special Disability Trust (SDT). This trust keeps people with disabilities from losing their government benefits. An individual with special needs can continue to receive the government funds required to sustain their life. That's because Centrelink— Australia's government agency that provides social security payments and services to Australians— does not include an SDT in their income or assets tests which dictate the fortnightly payment you're entitled to.
Because this area of estate planning can be complex, getting help from a qualified expert is a good idea to make sure everything follows the rules set by the government. In case you need help understanding more about how testamentary trusts can offer you or your loved ones benefits, feel free to reach out to our financial planners.
Is a Testamentary Trust a Discretionary Trust?
In some way, yes - although a testamentary trust can only be activated upon death, whereas a discretionary trust can be established at any time. A testamentary trust acts as a type of discretionary family trust in that the trustee can decide how and when to distribute income and lump sums from the trust. This flexibility allows for:
- Tax-effective distribution of income and capital gains tax.
- Asset protection from external claims.
- Customisation of financial support for beneficiaries, based on their needs and circumstances.
Setting the Beneficiaries of a Testamentary Trust
The beneficiaries of a testamentary trust typically include:
- Immediate family members, such as children, spouses, or grandchildren.
- Extended family members or close friends.
- Charitable organisations or special causes.
- Individuals with special needs require financial support.
The trustee decides how and when to handle fund distributions, ensuring they reflect the wishes of the person who set up the trust and meet the needs of the beneficiaries.
Are There Administration and Maintenance Costs to a Testamentary Trust?
Yes, there are ongoing costs associated with maintaining a testamentary trust, including administrative and maintenance costs. Here's a breakdown of the most common:
Administration Costs
- Legal Fees — Drafting a Will with a testamentary trust can be more complex than a simple Will, leading to higher legal fees.
- Accountancy — Trusts need to file annual tax returns, and accounting fees are incurred for this, potentially ranging from a few hundred to several thousand dollars annually depending on the complexity of the trust.
- Trustee Fees — If a professional trustee is appointed, they will charge fees for their services, which often represent a percentage of the trust's assets and an annual fee.
Maintenance Costs
- Trust Administration — The trustee is responsible for ongoing trust administration, including maintaining records, managing assets, and complying with legislative requirements.
- Financial Management — This includes keeping financial statements, particularly if the trust has debts or is making investments, and can incur additional accounting costs.
- Beneficiary Meetings — The trustee may need to meet with beneficiaries to review the trust and make distributions, which can also incur costs.
The total cost for any testamentary trust will depend on several factors, including:
- Complexity of the Will —A complex Will with a testamentary trust will likely lead to higher legal fees.
- Type of Trustee — Using a professional trustee will result in higher fees than using a family member or individual.
- Complexity of the Trust — Trusts with more complex assets or investment strategies may require more extensive accounting and administrative services.
You can always seek a tax or finance specialist to provide advice. That way, you have a more effective and cost-efficient trust structure in the long run, and a better picture of how to navigate the complexities of testamentary trusts.
Although the costs can differ based on how complicated the trust and assets are, the long-term advantages usually make it worth the administrative fees - and especially for wealthy families (e.g. estate assets exceeding $1,000,000). Costs may also depend on the marginal tax rates of different beneficiaries and the superannuation fund of the deceased.
Can Someone Contest a Testamentary Trust?
A testamentary trust can be contested if there are disputes over the validity of the will. Common grounds for contesting include:
- Claims of undue influence or coercion.
- Allegations of fraud or forgery.
- Concerns about the testator’s mental capacity at the time of drafting the will.
One or more beneficiaries who feel aggrieved can take legal action. To avoid disputes, it’s best if the will is properly executed and professionally drafted.
How to Set Up a Testamentary Trust in Australia
The legal process for getting a testamentary trust requires careful consideration and knowledge of legislation in Australia. Here’s what you need to know:
1. Draft a Will with Testamentary Trust Provisions
- Your will must explicitly state the terms and conditions of the testamentary trust.
- The trust must be structured in a way that aligns with Australian legal standards.
2. Appoint a Trustee
An essential part of managing the testamentary trust is the trustee. They are in charge of overseeing the management of trust assets, allocating money to beneficiaries, and making sure that all financial and legal requirements are met. When choosing a trustee, take into consideration:
- Credibility and financial knowledge- The trustee must be trustworthy and have the ability to handle financial concerns.
- Professional vs. personal trustees- While a close friend or family member may act as a trustee, professional trustees—such as financial or legal specialists—can offer more knowledge and objectivity.
- Ongoing obligations- By the testator's desires, the trustee must distribute assets, supervise tax obligations, and manage investments.
3. Check for Compliance with Australian Trust Laws
Testamentary trusts are governed by Australian law to ensure their fair and transparent operation. Important legal requirements consist of:
- Adherence to state inheritance laws- When creating a testamentary trust, certain rules must be adhered to in each Australian state.
- Tax responsibilities- The trust has to abide by the Australian Taxation Office's (ATO) rules regarding beneficiary distributions and income tax reporting.
- Legal documentation- To prevent disputes, the trust deed must specify terms, conditions, and beneficiaries' rights in detail.
Considering the intricacy of compliance, obtaining legal and financial counsel guarantees that the trust will continue to be legitimate and beneficial to all parties.
4. Ongoing Administration and Compliance
The trustee is responsible for ensuring tax compliance, reporting, and adhering to trust regulations. Regular professional guidance can help maintain the trust’s integrity and effectiveness.
Since setting up a testamentary trust can be quite involved, it's wise to collaborate with an experienced estate planning professional to ensure everything is done right and make the most of tax savings and protection for assets.
Final Thoughts
Bequeathing your assets via a testamentary trust can offer far better outcomes for your beneficiaries, and peace of mind for you. The benefits include tax reduction, asset protection, and the ability to control the distribution of wealth. To optimise its value, we highly advise that you seek professional help. Setting up a testamentary trust is a good decision to preserve your legacy and secure your family's financial future.
Do you need help setting up a testamentary trust? Northeast Wealth specialises in estate planning. We can help you a plan tailored to your unique situation and context. We reject the normal one‑size‑fits‑all approach that some planners might take and consider every detail and bit when building your family's financial future for generations to come.
Our financial planners are ready to help you create a rock-solid plan to protect and maximise your wealth and assets. Get in touch with us for a free and no-commitment consultation.
James O’Reilly is the Director of Northeast, a fast-growing financial advice firm that empowers clients to achieve meaningful financial progress and well-being. He's also the co-host of the Australian Retirement Podcast, one of Australia's fastest-growing podcasts.