A testamentary trust is, put very simply, a trust that is established within your will.
As such, a testamentary trust does not begin to operate until and unless you die.
This differentiates testamentary trusts from other trusts that may be established to operate during your lifetime, which we lawyers call inter vivos trusts (commonly known as family trusts).
If you have a family trust already, it will be one of these so-called inter vivos trusts, the terms of which are usually recorded in the form of a trust deed, a document of as many as 100 pages in length.
The terms of the testamentary trust, as set out in your will, are similar but nowhere near as detailed as those contained in most family trust deeds.
Why are testamentary trusts useful?
Testamentary trusts can be advantageous in a variety of cases.
Commonly our clients want testamentary trusts incorporated in their wills because:
- One or more of their beneficiaries have potential risk issues (e.g. in the case of a child who is bankrupt or who has a drug dependency or gambling addiction);
- They would prefer to protect the assets in the testamentary trust from claims by spouses of their children because there is a real risk that they may separate and be involved in a matrimonial property dispute.
Benefits of testamentary trusts
There are significant benefits of testamentary trusts, as in the case of family trusts, but it is important to get independent accounting and financial advice before seeking our advice as to whether the benefits are worth it for you.
The main benefits are:
- Asset protection:A testamentary trust can provide significant asset protection which will be important if your surviving spouse or an adult child owns a business or is engaged in an occupation that carries significant risk of litigation.
- Income splitting:There is a tax benefit in that under a testamentary trust, all beneficiaries, including beneficiaries under the age of 18, receive the benefit of the full income tax free threshold, and income above that amount is taxed at normal adult rates.
This means that approximately $20,000 can be distributed to each beneficiary free of tax each year.
- Flexibility:You can essentially do what you want in your will and tailor the terms of a testamentary trust to suit what you want to happen to your assets that are held within the trust along with the rest of your estate.
For example, you can restrict access to the assets in a testamentary trust in appropriate circumstances such as where a beneficiary has a disability or an addiction.
Who can be the trustee?
Anyone over the age of 18 can be the trustee of a testamentary trust, but the executor of the will is commonly also the trustee.
As is the case when deciding who your executor should be, your trustee should be an individual or company that you know and trust, because the trustee, by their very definition, will be entrusted with and have effective control the assets within the testamentary trust.
The trustee can also be someone independent to protect beneficiaries if they cannot look after the assets themselves. Sometimes it may not be appropriate for a surviving spouse or a child to be the sole trustee of their trust, or to be a trustee at all.
For trusts established for adult children, all the children are usually the trustees of each of the trusts. It is important to have more than one trustee if you want to give some protection for your children in a matrimonial property settlement. However, each child can have the power to appoint themselves as the sole trustee of their own trust.
Who can be beneficiaries of a testamentary trust?
Usually testamentary trusts are created because the will-maker is concerned about protecting their spouse and/or their (infant or adult) children.
For a testamentary trust established for the purposed of protecting a surviving spouse, the main beneficiary will either be the spouse or the children (depending on whether the intention is to preserve the assets for the children) and your blood descendants.
Generally a testamentary trust is structured so that the trustee has full discretion to make distributions of capital at any time.
This means that the surviving spouse can decide how to distribute the income from the trust that the capital is preserved for the children.
For a testamentary trust established for the purposed of protecting adult children, the beneficiaries are usually the children, their children and their grandchildren. Spouses of these beneficiaries are usually potential income beneficiaries. This means that income can be distributed to them to reduce the tax that the child’s family group will pay. However, spouses do not have a right to distribution from the trust unless the trustee decides to distribute to them.
What to consider before establishing a testament to trust
As with family trusts, there will be ongoing administrative costs involved in maintaining your testamentary trust which could potentially be many years after your death, such as accountancy fees and financial planning fees.
Therefore factors you should consider whether a testamentary trust is right for you and your estate are if:
- you hold or your estate is likely to hold significant assets;
- the income generated by your estate is likely to be sufficient to warrant a testamentary trust;
- there are special needs such as a beneficiary with an intellectual disability or an inability to manage money; or
- the risk profile of a beneficiary justifies a testamentary trust as part of an asset protection strategy.
If you found this information helpful, and you are wanting to make a new will, with or without a testamentary trust, or review your existing will as part of your estate planning, please do not hesitate to contact us on 8276 7955 or email us at firstname.lastname@example.org.