Incorporating a testamentary trust within your will can provide significant flexibility and control over the distribution of assets to beneficiaries, as well as protect your assets and reduce the taxes paid by those who benefit from your estate.
A testamentary trust (sometimes referred to as a will trust or a trust under will) is an established trust which only arises upon the death of the individual. Under a testamentary trust the Trustee has the discretion to distribute capital and income between a group of beneficiaries nominated in your will.
Testamentary trusts are increasing in popularity as more people become aware of their significant advantages. The reasons why you should consider a testamentary trust include:
Capital Gains Tax benefits (CGT)
In most instances, there is no Capital Gains Tax when an asset is transferred from the trustee of a testamentary trust to a beneficiary. Assets owned by the deceased that would have been subject to CGT had the deceased sold them before their death, can pass through their estate to a testamentary trust without a CGT event occurring. Eg. A house can pass from Grandparents to their son to their grand-son without triggering a CGT event. Capital gains is triggered on the selling of an asset, however with a testamentary trust any CGT liability incurred upon selling an asset can be spilt among the beneficiaries and their wives and children, ultimately reducing the amount payed. If an asset was a pre-CGT asset, the trust will receive a cost base equivalent to the market value of the asset at the date of death. If the asset is a post CGT asset, then the trust will inherit the deceased’s cost base.
Income Tax Advantages
A testamentary trusts can have significant advantage of enabling the trustee to stream or split income amongst the trust's discretionary beneficiaries in a way that minimises overall tax paid on the trust's income. The trustee may decide which beneficiaries receive trust income. The beneficiaries that receive the trust income then include this income in their own assessable income which is taxed at that individual's marginal tax rates. With the current tax-free threshold of $18,200, beneficiaries are potentially able to receive up to $18,200 of tax free income from the testamentary trust each year. Income can be distributed from a testamentary trust to infant beneficiaries (under the age of 18) and taxed at these adult marginal tax rates. Without a testamentary trust minors may only access a $416 tax-free threshold with thereafter 66% of income up to $1,307 and 45% after $1,308, on the entire amount of income received.
Flexibility to the trustee The trustee can buy and sell underlying assets of the trust (and thereby enhance the value of the trust) without losing or endangering any tax advantage. We suggest it is desirable that clients provide the trustee with some guidelines about the administration of the trust, but they should be carefully framed in order to avoid any confusion or legal or accounting complications.
Protection of assets
Testamentary trusts provide a level of protection to the assets held in the trust. This includes protection against creditors of the beneficiaries for example if a bankrupt has received an inheritance through a testamentary trust it will be protected from creditors. Also in the Family Court, an inheritance held within a testamentary trust is unlikely to be the subject of a Family Court order in the case of a divorce.
Protecting ’at risk’ beneficiaries
Testamentary trust can be very beneficial to “at risk” beneficiaries to ensure their inherited finances are properly managed. At risk beneficiaries are people suffering a variety of disabilities for example people who are drug or gambling addicted, mentally or physically disabled or simply spendthrifts who are not capable of looking after any wealth that is left to them. Families may wish to ensure that an adequate fund is set up to meet the beneficiaries’ reasonable needs in a way that does not affect any pension rights they may have. For these people, a testamentary trust can be managed by a trustee (who should be) a responsible and capable person (or people) who take action for the benefit of the ’at risk’ person.