Testamentary trusts offer many advantages for people putting together a Will who hope to have greater control over the distribution of their assets following their death. A testamentary trust allows for tax benefits, as well as protection of assets from creditors or family disputes.
What is a Testamentary Trust?
Testamentary trusts are trusts built into Wills that allow for more controlled distribution of assets. They place a trustee in charge of the trust, who holds assets on behalf of the beneficiaries and can distribute those assets when they want to. Beneficiaries of the Will can still manage their inheritance, but under the law the assets are not owned by them. This means the funds cannot be involved in financial disputes and are not subject to the same tax rates.
Benefits of Testamentary Trusts
There are many advantages to testamentary trusts and they are highly recommended for people who want to maximise the wealth inherited by their beneficiaries.
Income Tax
Children who receive an inheritance are taxed an exorbitant amount on any gift of over $1000. This can severely affect the amount that you are able to leave for people under 18. However, when you set up a testamentary trust, children are taxed at a much lower rate. This can help to ensure that your young beneficiaries receive the amount intended for them, without a large portion of it going to the tax office.
The trustee can also minimise the tax liability of the trust by choosing to distribute income from the investment of the trust between beneficiaries with lower marginal tax rates. This can equate to millions of dollars in saved tax over the long term.
Capital Gains Tax
Capital gains tax is the tax you pay on profits from selling assets, such as property, shares and bonds. Testamentary trusts allow beneficiaries to minimise Capital Gains Tax, as there is no tax when assets are transferred from the trustee of a testamentary trust to a beneficiary.
As with income tax, trustees can distribute the capital gain to beneficiaries on lower incomes to minimise the tax. Additionally, assets can be held in the trust for as long as needed, deferring the need to pay Capital Gains Tax.
Asset Protection following New Relationships
Wills and the distribution of assets after a person’s death can become complicated when there are numerous people involved. This is exacerbated by divorces and new marriages or de-facto relationships. Sometimes, the person you wanted to be a beneficiary is left with less in favour of new partners.
For example, if you pass away you may leave a significant portion of your assets to your spouse. But if they remarry, those inherited assets could now be passed on to their new partner and any subsequent children, diluting the amount that can be left for your own children and other beneficiaries.
A testamentary trust can avoid this situation. Assets are held in the trust and protected for nominated beneficiaries only, unable to be accessed by others.
Assets held in a testamentary trust may also be protected against litigation in Family Law, so if your marriage breaks down and you have been the recipient of an inheritance that is held in a testamentary trust, your ex-spouse won’t be able to access those assets.
Asset Protection against Bankruptcy
When a testamentary trust is in place, it is at the discretion of the trustee to distribute assets. This can protect the beneficiaries from having their inheritance taken from them if they are experiencing financial problems, such as being declared bankrupt. Normally inheritances can be claimed by creditors, but assets held in a testamentary trust are protected because the beneficiary has no actual entitlement to them.
This can also be effectiveness in other circumstances when you want to leave money to a beneficiary who can only access it at a certain time. For example, grandparents may want to put aside money for the grandchildren’s school fees, or someone may like to stipulate that a beneficiary cannot receive assets if they are dealing with an addiction problem.
Long Term Solution
A testamentary trust can be valid for up to eighty years. This means it can benefit not only your beneficiaries, but two or three generations following them. Testamentary trusts can be dissolved at any time, and distributions made to beneficiaries.
How to Arrange a Testamentary Trust
Testamentary trusts can be written into your Will. When you prepare a Will with a professional, they can assist you to arrange the trust and provide the rules by which the trust is managed.
Your Executor should also be closely involved in the arrangement of your testamentary trust. After you die, your Executor will meet with your lawyer to review the terms of the trust (or trusts) in the Will and set up the testamentary trust according to your wishes. If your Will does not include testamentary trust provisions and terms, your beneficiaries cannot use testamentary trusts after you die.
Testamentary trusts require a tax file number and for a tax return to be lodged annually, with administrative costs paid for by the trust.
