Testamentary Trusts

Estate planning is about more than just preparing a valid Will. It’s about making sure your family is provided for and that your assets go where you want them to after you die.

A good estate plan can:

  • ensure the ownership and control of your assets passes to your intended beneficiaries in the right proportions;
  • minimise the tax impact on your estate and beneficiaries;
  • ensure your estate is administered in a cost-efficient and timely manner;
  • protect assets if a beneficiary is involved in any legal difficulties (for example, bankruptcy or divorce) or under a legal disability.

Essentially, a good estate plan can provide you with peace of mind and help avoid potential complications for your beneficiaries.   Where taxation and asset protection are significant concerns a testamentary trust may be the structure to address these concerns. 

What is a testamentary trust?

A testamentary trust is a trust created by a Will and involves the distribution of whole or part of the deceased’s assets upon the death of the testator.   It provides for the capital and income of those assets to be applied in favour of particular beneficiaries in accordance with the terms of the testamentary trust deed.

What assets can be held in a testamentary trust?

Only those assets which are captured by the deceased’s Will form part of a testamentary trust i.e. those assets owned personally by the deceased.   Assets held in other entities such as superannuation and family discretionary trusts do not necessarily form part of the deceased’s estate upon death.  

Assets held in superannuation are subject to payment by the trustee of the superannuation fund and in the absence of any valid binding death nomination are paid at the trustee’s discretion.

Assets held in a family discretionary trust remain as the assets of the family discretionary trust deed and subject to the terms of that deed.   However, it is important to note that loan accounts and unpaid present entitlements in favour of the deceased in their individual capacity may form part of the deceased’s estate. 

Assets owned jointly with other individuals do not form part of the deceased’s estate and will pass in accordance with the rules of survivorship to the surviving tenant regardless of the provisions contained in the deceased’s will.

Types of Testamentary Trusts

A testamentary trust is like an inter vivos trust such as a family discretionary trust and includes amongst other things:

  • Details of the trust fund;
  • Details of the beneficiaries of the trust;
  • Appointment and termination of the trustee;
  • Powers of the trustee;
  • Appointment and termination of the Appointor;
  • The terms for payment of capital and income of the trust.

Testamentary trusts can be fixed, discretionary or hybrid trusts.   The most common type of testamentary trust is a discretionary trust and is the focus of this blog.

The Roles within a Testamentary Trust

  • the Trustee;
  • the Appointor; and
  • the Beneficiaries.

The Trustee is responsible for the administration of the trust in accordance with the terms of the trust deed and is responsible for the day to day management including investment and distribution of income and capital.    The trustee of a testamentary trust can be the Executor of the deceased’s will, the primary beneficiary, an independent third party or a combination of people.   The trust deed will provide mechanisms for the appointment and replacement of the trustee.   To avoid conflict of interests and transparency that the trust is being operated for the benefit of all beneficiaries it is important to carefully consider who is appointed to the role of trustee and who will act in the best interests of all beneficiaries and not favour one beneficiary over others. 

The Appointor is a crucial role in a testamentary trust and is the person who can appoint and remove the Trustee and the Appointor’s consent is required for the trustee to exercise particular powers, such as varying the trust terms, distributing capital, adding beneficiaries and changing the vesting date of the trust.   It is common for a testamentary trust controlled by a primary beneficiary to have an independent or joint Appointor which provides for separation of the control of the trust.

The Beneficiaries of a testamentary trust usually have a wide range of potential beneficiaries that the Trustee can decide to distribute income and capital of the trust to.   The trust deed normally defines a Primary Beneficiary and includes the Primary Beneficiary’s extended relations (such as spouse, children, grandchildren, parents, siblings).   A beneficiary of a discretionary testamentary trust does not have a right to call for any of the unallocated income or capital of the trust.   A beneficiary’s only right under a discretionary testamentary trust is to call upon the trustee for the due administration of the trust, that is, a beneficiary is only required to be considered by the trustee and does not have any proprietary interest in the assets of the trust fund.

Advantages of a testamentary trust

Testamentary trusts can provide flexibility when distributing income of the trust and offer better protection for beneficiaries that may face financial difficulty or family law difficulties. 

Income streaming in a discretionary testamentary trust

Depending on the terms of the trust, income generated from the testamentary trust may be divided amongst a wide class of beneficiaries including children under the age of 18 years.   Under current taxation laws, distribution of income paid to children under 18 years from a testamentary trust would see the children taxed as adults (as opposed to taxation at penalty rates for income distribution in excess of $416 per financial year under a family discretionary trust as set out below).

Income Tax rates for trust income distributed to a minor beneficiary as excepted trust income under a testamentary trust under paragraph 102AG(2)(a)

Income

Tax Rates

$0- $18,200

Nil

$18,201 - $37,000

19% of the excess over $18,200

$37,001 - $90,000

$3,572 plus 32.5% over $37,000

$90,000 - $180,000

$20,797 plus 37% over $90,000

$180,001 and over

$54,097 plus 45% over $180,000

 Income Tax rates for distributed to a minor beneficiary

Income

Tax Rates

$0- $416

Nil

$416 - $1,307

Nil plus 66% of the excess over $416

Over $1,307

45% of the total amount that is not excepted income

Another advantage of a testamentary trust is that it can provide for some protection for the primary beneficiary if the primary beneficiary is facing financial difficulty or family law difficulties. 

Where a beneficiary is subject to an attack by its creditors, where the income or capital has not been allocated to the beneficiary the subject of financial difficulty, the inheritance left behind is protected on the basis of ordinary trust law principles, that none of the beneficiaries of the discretionary testamentary trust has a proprietary right to receive income or capital of the trust and are reliant on the trustee electing to make a distribution in their favour.

Similarly, a discretionary testamentary trust can provide some protection for the primary beneficiary in the event of a family law dispute. The Court may make orders in relation to financial matters following the breakdown of a relationship in respect of dividing the assets of the relationship of the separating couple, regardless of the whether the parties are married or in a defacto relationship.

Section 79 of the Family Law Act 1975 (Cth) (“the Family Law Act”) provides a wide discretionary powers to the Court to vary the legal interests in any property of the parties to the relationship and make orders for a settlement of property in substitution for any interest in the property. 

The Family Law Act distinguishes between “property” and “financial resource” for the purposes of property division and settlement.   Property is defined as “property to which those parties, are or that party is; as the case may be, entitled, whether in possession or reversion”.   This would include assets of the relationship such as a joint family home, bank accounts, etc. Financial resources, on the other hand, is not defined within the Family Law Act but are generally assets, rights and/or powers which are not property to be included in the relationship asset pool but a factor for the Court to take into account in dividing property of the relationship under section 79 because it has a future financial benefit to one party.  As this is a broad definition it includes resources that have the ability to generate income – for example, a beneficial interest in a trust.

Whether trust assets will be considered as property of the relationship to be divided under section 79 of the Family Law Act depends on the facts and circumstances of each case.   The Court has wide powers to disregard trust structures and associated trust law principles.   The decisions handed down by the Court so far provide guidelines as to when trust assets could be deemed property of the relationship pursuant to section 79 of the Family Law Act:

  • where one party of the relationship has effective control (either as trustee and/or appointor) and benefit of the trust;
  • where both parties are able to and have benefited from the income and capital of the trust;
  • whether the assets held in the trust were contributed to or acquired through the efforts of one or more parties to the relationship; and
  • whether the assets held in the trust have been deemed or assumed by one party to be an asset of the relationship.

Disadvantages of a testamentary trust

A key issue for consideration in establishing a testamentary trust is whether the costs of establishment and ongoing administration of the trust outweigh the benefits provided.  

The administration of a testamentary trust requires the involvement of professionals such as accountants (preparation of financial statements and tax returns) and lawyers (legal advice in respect of establishment, administration and vesting of the trust).   This means substantially more costs compared to providing the inheritance to the beneficiary as an outright right.

The benefits of control and asset protection may be in conflict i.e. the asset protection benefits of a discretionary testamentary trust is greatly reduced where the primary beneficiary is the sole effective controller of the trust. This can be addressed by appointing co-controllers, however, this, in turn, compromises the control of the trust by the primary beneficiary and may result in conflict between the co-controllers being with it an array of other issues.

There is no one size fits all in testamentary trust and careful consideration should be given to the objectives and priorities when devising your estate and succession plan. This publication provides an overview or summary only and it shouldn’t be considered a comprehensive statement on any matter or relied upon as such.   If you have further queries in relation to whether a testamentary trust is an appropriate structure for your estate plan, please contact our office for further advice.

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