What is a Testamentary Trust
Good estate planning requires you, as the testator, to think about what will happen to your assets when you die. A properly drafted Will is usually the starting point in documenting your wishes in respect of the treatment of your assets following your death. Without a Testamentary Trust, in most cases, your assets are distributed directly to your beneficiaries. If your Will contemplates a Testamentary Trust, your assets are dealt with in accordance with the terms of the Testamentary Trust (rather than immediately distributed to your beneficiaries).
A Testamentary Trust is like a standard discretionary trust except that it comes into effect after your death. It enables the distribution of income and assets to a broader group of beneficiaries. The Trustee of the Testamentary Trust has authority to decide who will benefit, to what extent that benefit is given and when that benefit will be given.
Although there are many reasons for adopting a Testamentary Trust the two main advantages are:
1. The potential for income tax savings on beneficiary income; and
2. The protection of assets
Income tax savings on beneficiary income
When a beneficiary receives an inheritance due to them personally, income tax is paid on the income generated from the inheritance, at their personal marginal rate of tax.
Under a Testamentary Trust the income derived from a beneficiary’s inheritance can be shared amongst a number of potential beneficiaries. This means that distributions of income can be made to beneficiaries who are on a lower rate of tax (for instance spouses and children) thereby achieving tax savings.
Another potential tax savings for a beneficiary’s family is that there are significant concessional tax treatments afforded to the income derived by infant beneficiaries from a Testamentary Trust compared with the income derived by an infant beneficiary from a standard family trust.
Protection of Assets
One of the obvious reasons for holding a testator’s assets in a Testamentary Trust is to protect against claims made by third parties.
Asset protection covers many aspects, including:
- the breakdown of a beneficiary’s marriage;
- the insolvency of a beneficiary; or
- where a testator wishes to protect against the possibility that a primary beneficiary might irresponsibly waste the inheritance that has been given to him or her.
Breakdown of a beneficiary’s marriage
In the event of a proposed beneficiary’s marriage breaking down, a divorcing beneficiary could argue that the assets of the Testamentary Trust do not form part of the assets of the marriage and therefore should not be taken in account in a property settlement. Whilst this is not always guaranteed protection (as the Family Court can pierce the ‘corporate veil’) generally speaking, assets held in trust for a divorcing beneficiary offer better protection compared to a direct inheritance immediately received by a divorcing beneficiary.
The insolvency of a beneficiary
If a proposed beneficiary is at risk of being exposed to potential legal or commercial risks such as insolvency or negligence (usually due to the beneficiary’s occupation), the assets held in the Testamentary Trust (for the benefit of that beneficiary) will be safe guarded against third party claims.
Risk of loss of inheritance by irresponsible beneficiary
A Testator may wish to safe guard a beneficiary from wasting his or her inheritance. The terms of a Testamentary Trust will give the Trustee discretion as to what extent that benefit is given and when that benefit will be given. This will ensure that a beneficiary is unlikely to receive his or her benefit in full and have the opportunity to waste it.
The Disadvantages of a Testamentary Trust
Establishing a Testamentary Trust adds an initial additional cost to that of preparing just a standard will (without a Testamentary Trust). After the death of the testator, there are the ongoing costs associated with the management of the Testamentary Trust. These ongoing costs typically include fees for accounting advice and the preparation of tax returns.
There is also the difficulty of finding an appropriate Trustee for your Testamentary Trust. That person needs to be someone who you can trust will act in the best interests of the beneficiaries. A Trustee could be your professional adviser however there would be costs involved in having your professional adviser act as the Trustee.
Obviously the advantages will need to be weighed against the disadvantages in light of your own particular circumstances. One determining factor may be the nature and value of the assets likely to be available to the Testamentary Trust in the event of your death. Another may be the age and vulnerability of the beneficiaries. Generally speaking though, if you are unlikely to die leaving behind assets of significant value, then a Testamentary Trust may not be appropriate.
For further information, please contact the author.
This article is posted in Adelaide, South Australia by Tri-meridian Corporate & Commercial Law and is intended to be used as a guide only. It is not, and is not intended to be, advice on any specific matter. We do not accept responsibility for any acts or omissions resulting from reliance upon the content of this article. Before acting on the basis of any material in this article, we recommend that you consult your professional adviser.