A testamentary trust is a trust created by your will after you die and involves leaving some or all of whatever assets remain in your name, as at the date of your death, into a trust fund for which your Executor (or someone else) will hold at law and administer as a trustee.
When you are planning for your succession, there can be significant advantages in setting up a testamentary trust for the benefit of your children.
You can choose who you would like to act as your Executor(s) and/or trustee(s) of your estate, and it would usually be that at least one would be your partner and/or one or more of your children.
Usually, the income (and/or capital) beneficiaries of the trust will be your partner, your children and/or your grandchildren, and your Executor will have the discretion to be able to apply or distribute the income between himself/herself and the other beneficiaries.
So why should you consider having a testamentary trust in your will?
You may not know what will happen to your children after you die, their financial situations may change, they may get married, they may get separated, they may have other children, one may become much needier or the other much richer. In many of these situations, you may prefer more flexibility for your estate to take into account these changing circumstances.
A testamentary trust can give that flexibility and allow your Executor to apply or distribute income in their discretion.
You can choose who you would like to be the beneficiaries, and even how you would like the assets to be distributed, or leave it more open for your Executor to decide.
Protect assets from creditors and marriage misadventure
The testamentary trust structure can be useful to protect assets in a bankruptcy or from other creditors of your partner, children, other beneficiaries, and their businesses if any.
The testamentary trust structure can also help protect your children from misadventure in their marriages. After a divorce or separation, the Family Law Court has significant discretion in making a property settlement order, and your bequest may be included in the pool of assets from which a property division is made. A trust structure will mean that your bequest is better protected from such a property division.
This also applies in the event of your spouse marrying again.
However, a trust structure will not protect assets from a property division in all situations and it is important to get specific legal advice in relation to your particular circumstances if you are concerned about this.
Support your children’s and grandchildren’s needs
A trust structure, because of its flexibility in catering for more beneficiaries, and responding to changing circumstances, can be particularly effective in providing for your children’s and grandchildren’s needs.
What you can set up the testamentary trust to do is, for example, during your Partner’s life (whom you assigned as Executor and trustee) they would distribute or apply the income and/or capital from your estate for the benefit of themselves and your children and grandchildren, as needs arises or in a manner to maximise tax savings, and upon their passing, assuming he/she survives you, then that trust fund can be split into any number of separate trusts (depending upon the number of children who survive you).
For example, imagine this scenario. You have two children, M and F. Upon your Partner’s death, the trust is divided into two (2) separate trusts. A half of that residual estate will be held upon trust for M and his children for a period of time during his lifetime [or until her youngest child attains a certain age] after which the trust is wound up. At that stage, the capital could pass to M and his children at his discretion. Similarly with F.
M and F can also apply some of the capital for their children’s/your grandchildren’s benefit during the term of the trust if appropriate without having to wait for the trust to be wound up. And so, effectively your grandchildren may be able to pay part of their own school fees!
You can set up similar trusts for all of your children as well as make special provisions for the needs of a child with a disability or other special need.
Take advantage of tax savings
Similar to a discretionary family trust, your Executor or trustee is able to distribute the income from a trust in their own discretion and can do this in a way that can maximise tax savings. This can be particularly effective if there are family members with lower income as they will pay tax on lower nominal rates.
Since the spouses of your children can be beneficiaries, there are potentially a larger number of individuals to whom the income can be distributed, and there can be significant tax savings.
This is especially relevant where there are children under the age of eighteen (18) as beneficiaries because currently, effectively, all children under the age of eighteen (18) are able to receive income as though they were an adult, if the income is generated from a fund which is held in a testamentary trust. This is in contrast to income received from a family trust for children under the age of eighteen (18) which is taxed at higher penalty rates.
Superannuation benefits to pass to the trust and not your partner
It may be that whatever superannuation benefits that would otherwise pass between you to your Partner, or vice-versa – may be better served by being directed into one of these testamentary trusts, in your respective estates.
Such a gift could then lose the benefit of the tax-free nature which would exist if the super benefit were to pass to a Partner, but it would then increase the fund for the purposes of distribution of income through the various testamentary trusts to your children/grandchildren.
Where a testamentary trust may not be appropriate
A testamentary trust will not be appropriate in every situation. For example, If you have assets not under your personal name or if you have assets held in a family trust (in that case they will continue to be held in that trust, subject to the terms and conditions relating to that trust), they will not pass into the testamentary trust.
Moreover, many of the advantages of a testamentary trust may only be realised or realised fully in certain conditions and family situations. This depends on a myriad of factors including the size of your estate, the type of assets, existence of other trusts, number of beneficiaries, other income of beneficiaries etc.
We would like to caution that we are not providing you with financial advice, but rather general legal advice in relation to how assets could be distributed effectively, if the circumstances were appropriate, and we would also recommend you to seek independent financial advice in relation to the income effectiveness, or otherwise, of this structure.
If you would like to know more, or have any other questions in relation to the content of this page, feel free to contact our legal team on 02 9232 8033.