What is a Testamentary Trust?
A testamentary trust is essentially a trust that is established through a person’s last will and testament.
Unlike discretionary or family trusts, which are typically created separately during an individual’s lifetime through a trust deed, testamentary trusts are integrated into the terms of the will itself.
These trusts only become active and operational upon the death of the person who made the will (the Willmaker), and they play a crucial role in managing and distributing assets as part of the deceased’s estate.
Distinctive Features of Testamentary Trusts
While testamentary trusts function similarly to other types of trusts, they offer their own unique benefits, particularly in terms of asset protection within a family context. Some specific features of testamentary trusts include:
- Trustee Beneficiary Separation: Testamentary trusts, like all trusts, maintain a clear separation between the trustee, who is the legal controller of the trust, and the beneficiary, who is entitled to the trust’s income. This separation provides significant asset protection, especially for primary beneficiaries who may be at risk of financial challenges or external claims.
- Tax Liability Management: One of the remarkable and distinctive aspects of testamentary trusts is their ability to facilitate the division of tax liability on inherited income and the assets of the deceased among family members. This can lead to more efficient tax planning and potentially reduce the tax burden on the beneficiaries, ensuring that wealth is preserved and distributed in a tax efficient manner.
- Varied Purposes: Testamentary trusts can serve different purposes, including private family trusts or charitable trusts. They offer flexibility in meeting the diverse needs and goals of the testator.
Testamentary Trust Will vs Standard Will
In a typical standard Will, beneficiaries receive their inheritances directly in their personal capacity, resulting in assets being transferred into their individual names. However, this approach exposes these assets to various risks, including potential demands to cover debts and tax obligations.
In contrast, when employing a Testamentary Trust Will, the beneficiary does not acquire their inheritance from the estate on a personal basis.
Instead, their inheritance is directed into the Testamentary Trust, where it is subsequently managed by the appointed Trustee. Within this trust structure, the capital is distributed in accordance with the trust’s terms and, importantly, at the discretion of the trustee in the context of a discretionary trust.
The key distinction lies in how assets are received and managed: a standard Will delivers assets directly to the beneficiary’s personal ownership, while a Testamentary Trust Will funnels the inheritance into a trust, granting the trustee the authority to oversee and distribute the assets in line with the trust’s provisions and the trustee’s discretion.
This structural difference can offer enhanced asset protection and flexibility in the distribution of wealth.
Who Should Create a Testamentary Trust
The decision to establish a testamentary trust in a will should be based on specific circumstances and concerns. It may be advisable for individuals to consider a testamentary trust rather than direct distributions if they have the following concerns:
- Beneficiary Management and Protection: If beneficiaries are perceived to lack the capability to effectively manage or safeguard assets after the testator’s passing, especially in cases where they have lost mental capacity or are grappling with challenges like substance abuse, gambling issues, or excessive spending.
- Financial Vulnerability of Beneficiaries: In situations where beneficiaries might be at risk of encountering financial challenges, such as bankruptcy, divorce, or legal disputes that could potentially jeopardize the assets intended for them.
- Tax Efficiency: When beneficiaries are high income earners who would be subject to substantial tax liabilities upon receiving income generated by the assets. In such cases, the utilization of a testamentary trust can offer tax effective strategies for optimizing income distribution.
- Valuable Assets: Testamentary trusts prove particularly advantageous when an estate comprises valuable assets or a high value inheritance that necessitates meticulous management and safeguarding.
- Risk Management: As a protective and risk management tool, testamentary trusts excel in scenarios where asset protection is of utmost importance, ensuring that assets remain intact for the intended beneficiaries.
Other Specific Scenarios Where Testamentary Trusts Are Beneficial
Let’s explore few specific scenarios where testamentary trusts can prove to be valuable:
High Risk Beneficiaries: If you have beneficiaries engaged in high risk professions like firefighters, police officers, or active military service, or if they run businesses prone to negligence claims, considering a testamentary trust is prudent.
Creditor Protection: Testamentary trusts offer protective measures against creditors seeking to claim bequests from your beneficiaries. They also ensure that your beneficiaries’ inheritances are shielded from potential business debts of their spouses.
Education: For those wishing to provide funds for their grandchildren’s education, including expenses for boarding school and tuition, a testamentary trust can serve as a tax efficient means to fulfill this goal.
Divorce of a Child: Assets held within a testamentary trust are not considered the personal assets of any individual, preventing the Family Court from ordering the distribution of those funds. As a result, a testamentary trust effectively ensures that your divorced child receives their intended inheritance.
Remarriage of a Spouse: Concerns about a surviving spouse’s remarriage diverting the estate to a new family or potentially leading to unwise financial decisions can be addressed by using a testamentary trust as a safeguard.
Disabled Children: When there is a need to ensure that disabled or intellectually impaired children continue to rely on your estate for their well being, a testamentary trust can serve as an efficient management tool.
These scenarios illustrate the versatility and usefulness of testamentary trusts in addressing various estate planning concerns and safeguarding the financial interests of beneficiaries in unique situations.
Factors to Consider Before Establishing a Testamentary Trust
Before deciding to create a testamentary trust, one should take several factors into account:
Asset Level Suitability: Individuals should assess whether the value of their assets justifies the establishment of a testamentary trust. While there are no specific minimum asset requirements, it is essential to weigh the benefits against the associated costs. It’s important to note that testamentary trusts can only be formed using assets that belong to the estate. If a significant portion of assets is jointly owned or held within a family trust, these assets will not be part of the estate and cannot be utilized to establish a testamentary trust.
Contingencies for First Line of Beneficiaries: Consider the potential scenarios that may unfold concerning the trust and its assets upon the death of the initial line of beneficiaries.
Administrative Costs: It is crucial to factor in the expenses associated with trust administration. These costs can encompass professional trustee services and ongoing administrative expenses, such as accounting fees incurred for the preparation and submission of tax returns
Setting Up a Testamentary Trust Will in Australia
Establishing a Testamentary Trust Will in Australia is an integral part of estate planning, and the process involves several key steps, both before and after one’s passing:
Pre Death Steps
Identify the Assets
The initial step is to determine which assets will be transferred into the Testamentary Trust. This entails creating an inventory that encompasses the value of all assets, including property, cash, business income, and shares.
The testator can decide whether all assets should enter the Trust or if certain assets should be excluded or included selectively. Multiple testamentary trusts can be established, each with a different primary beneficiary, or assets can be allocated to separate trusts based on the intended beneficiaries.
Nominate a Trustee and/or Controller
A crucial aspect of establishing a testamentary trust is selecting an appropriate trustee. The trustee is responsible for managing the trust’s assets and ensuring that the life interest benefits are administered correctly. Here are the key considerations:
- Trustee Options: The trustee can be a family member, a friend who is over 18 years of age and an Australian resident. Alternatively, you can appoint a trustee company, such as State Trustees, or opt for a legal, accounting, or financial planning organization.
- Trustee’s Role: The trustee serves as the legal owner of the assets within the trust. They have a fiduciary duty to manage these assets in the best interests of the beneficiaries.
It’s worth noting that some benefits of a Testamentary Trust may diminish if the Trustee and beneficiary are the same person. Seeking advice from an estate planning lawyer to determine the best Trustee for the Testamentary Trust is advisable.
In certain cases, the executor of the will may also serve as the trustee.
Identifying the intended beneficiaries of the Testamentary Trust is a critical step. Beneficiaries can include a spouse, children, other family members, close friends, or even organizations.
Since a Testamentary Trust can remain in effect for up to 80 years (varies by state), careful consideration is essential when specifying who the beneficiaries will be beyond the primary beneficiaries’ lifetime.
Some may extend the line of beneficiaries to include their grandchildren while excluding their children’s and grandchildren’s spouses to safeguard Trust assets from potential family law proceedings.
Define Trust Terms and Structure
The terms and structure of the Trust need to be outlined, including which assets each beneficiary is entitled to and when they can access them. Testamentary Trusts offer the flexibility to restrict access until beneficiaries reach a specified age, such as 18, with provisions allowing the Trustee to release funds earlier for purposes like tuition fees or living expenses. Age restrictions can be adjusted to better suit the testator’s intentions, raising the age limit to 21 or 25, for instance.
Execute the Will
Once the Testamentary Trust Will has been drafted and properly signed in the presence of two independent adult witnesses, it becomes valid and in effect. There is no further action required until the testator passes away.
Post Death Steps
Notify the Beneficiaries
After the testator’s passing, the Executor of the Will should inform the beneficiaries that they have been named in the Will through a Testamentary Trust.
Some Wills offer beneficiaries the option to choose between receiving their inheritance directly in a personal capacity or through the Trust. If a beneficiary opts not to utilize the Trust, they should seek financial and legal advice to understand the implications of declining it.
Engage an Accountant and Apply for a Tax File Number (TFN)
All Trusts in Australia are required to have an associated TFN, which is used for tax returns related to the Trust.
An accountant can handle the TFN application process and provide financial guidance concerning the assets, the most effective methods for transferring them to the Trust, potential tax consequences during the transfer, and strategic advice regarding the ongoing management and distribution of Trust income to beneficiaries.
Administer the Estate
The Executors of the Will should proceed with the process of applying for Probate of the Will and liquidating the Estate’s assets.
Once this administrative process is successfully completed, the assets that constitute part of the Testamentary Trust can be transferred to the Trust. Accountants or tax lawyers can assist in facilitating this transfer and ensuring compliance with legal and financial requirements.
These post death steps are essential to ensure the proper implementation and administration of the Testamentary Trust as outlined in the testator’s Will, providing beneficiaries with the intended benefits and asset protection.
Cost of a Testamentary Trust in Australia
Drafting a Will that incorporates a Testamentary Trust is a complex and specialized legal process, typically conducted by an estate planning lawyer. The cost of such legal services can vary considerably and may range from around $3,000 to $8,000 in legal fees, depending on various factors.
Once the Will has been drafted to include a Testamentary Trust, there are generally no additional fees to be paid because the Trust does not become operational until the testator’s passing.
Subsequent to the testator’s death, there will be ongoing administrative expenses associated with maintaining and managing the Trust. These costs may include accountancy fees for the preparation of annual trust tax returns and other necessary administrative tasks.
How a Testamentary Trust Safeguards Assets
A testamentary trust offers protection for assets through the legal ownership held by the trustee, distinct from the beneficiaries. Consequently, these assets may remain shielded from potential threats, such as creditors pursuing beneficiaries in cases of bankruptcy or successful legal actions against them. Similarly, placing assets within a testamentary trust can provide a degree of protection in the context of divorce property settlements, although it’s important to note that the presence of a testamentary trust may offset other assets in the settlement.
Moreover, beneficiaries who are not also trustees do not have direct access to the assets within the trust to liquidate or utilize as they please. This restriction serves as a safeguard against beneficiaries who may mishandle their inheritance due to poor money management skills.
To establish these protective measures effectively, it is crucial to meticulously draft the terms of the testamentary trust within your will. Seeking legal advice is essential in ensuring that these safeguards are appropriately implemented.
Pros and Cons of a Testamentary Trust
Testamentary Trusts help protect your wealth and make sure your loved ones benefit the way you want them to. Let’s find out what are their benefits and how they can secure your family’s financial future.
Control Over Generations
Testamentary trusts provide the opportunity to exert control over assets for extended periods, potentially up to 80 years. This allows for provisions not only for children but also for grandchildren and even great grandchildren. The trustee, duly appointed, can manage and distribute assets in alignment with the testator’s wishes and the needs of successive generations.
Protection in Case of Remarriage or New Relationships
Without a testamentary trust, assets may inadvertently benefit a surviving spouse’s new partner or their family in cases of remarriage or new de facto relationships.
Testamentary trusts offer a safeguard, ensuring assets are directed towards the original testator’s children and grandchildren as intended.
Safeguarding Against Financial Troubles
Assets held within a testamentary trust are shielded from the creditors of beneficiaries facing financial hardships or insolvency. This means that their inheritance remains unaffected by debt settlement.
Support for Vulnerable Beneficiaries
Testamentary trusts prove invaluable when dealing with beneficiaries who have disabilities, health challenges, or addiction issues. These trusts facilitate careful management of inheritances, ensuring they are utilized for the well being of the beneficiaries, preventing mismanagement or loss.
Testamentary trusts present tax benefits, particularly for young beneficiaries under eighteen who are subject to lower tax rates on trust income. Capital gains can be distributed in a tax efficient manner, reducing the overall tax liability, particularly when beneficiaries have limited incomes.
Preserving Government Benefits
Assets held within testamentary trusts are not considered in the assessment of government benefits such as pensions. This ensures beneficiaries can receive their entitlements without concern about trust assets affecting their eligibility.
Efficient Handling of Superannuation and Insurance Proceeds
Although superannuation and insurance proceeds typically fall outside the scope of one’s estate, a well crafted will can direct these funds into a testamentary trust. This allows for controlled distribution and asset protection, ensuring the testator’s intentions are faithfully executed.
Certain drawbacks accompany the benefits of testamentary trusts, and it’s important to be aware of these potential disadvantages when considering their inclusion in an estate plan. These include:Top of Form
Testamentary trusts grant significant control to the appointed trustee, who has the discretion to manage and distribute trust income and assets. Ensuring a clear succession plan for the trustee’s role becomes crucial. This plan should be explicitly outlined in the Will if one wishes to determine the future controller of the trust upon their demise.
In cases where access to trust capital or income is restricted, beneficiaries might express dissatisfaction and potentially challenge the Will. Open communication with beneficiaries during Will preparation may reduce the likelihood of such challenges.
Additionally, trust administration may require cooperation among family members who share trustee responsibilities, which could lead to potential conflicts within the family.
Assets held within a testamentary trust should be of sufficient value to justify the expenses associated with trust administration. These expenses include the preparation and maintenance of accounts, as well as the annual filing of tax returns.
In the event that the trust holds capital assets that are sold at a loss, these capital losses cannot be distributed to beneficiaries. Instead, they are carried forward within the trust and set off against future capital gains, if any.
When either the primary beneficiary or another beneficiary is a pensioner, careful consideration is needed to ensure that the inheritance within the testamentary trust does not jeopardize the beneficiary’s pension eligibility. Inheritances can impact income testing for pensions.
Asset and Estate Planning
A Will that includes testamentary trusts typically forms just one part of a comprehensive asset and estate plan.
Other crucial aspects to consider in the overall plan include control of family companies and trusts post death, superannuation arrangements with binding death benefit nominations, business succession plans, enduring powers of attorney for financial decisions, appointment of enduring guardians for health directives, lifestyle decisions, and family law considerations.
Challenging a Testamentary Trust in Australia – Grounds for Contestation
Contesting a testamentary trust essentially involves challenging the will in which the trust is established. In Australia, individuals can contest a will if they have the legal standing to do so and can provide valid reasons for their challenge.
The legal right to contest a will typically extends to individuals mentioned as beneficiaries in the will or statutory heirs who would inherit in the absence of a will.
Acceptable reasons for challenging a will are:
Insufficient Testamentary Capacity: This pertains to situations where the individual creating the will lacked the mental capacity to fully comprehend their actions during the will making process. Such circumstances often arise from factors like mental illness, dementia, or other cognitive impairments.
Undue Influence or Coercion: If evidence suggests that the person creating the will was pressured or manipulated into including provisions that did not truly reflect their wishes.
Improper Execution: When the will was not properly signed and witnessed according to legal requirements.
Forgery or Fraud: If the will was forged or if the individual was deceived or forced into signing it under false pretenses.
Inadequate Provision for Family Members or Dependents: Some family members and dependents have the right to contest the will if they believe they have not received a fair share of the deceased’s estate.
It’s important to note that contesting a testamentary trust often revolves around assessing the validity and circumstances of the will itself. Those considering contestation should seek legal advice to determine their eligibility and evaluate the merits of their case based on the grounds for contestation that apply in their situation.
This article is for general information only. It does not make recommendations nor does it provide advice to address your personal circumstances. To make an informed decision, always contact a registered tax professional.