FocusOn - Testamentary Trusts
A testamentary trust is a discretionary trust established by a Will that commences at the date of death. A testamentary trust is used to retain some or all of the deceased’s estate in a trust, rather than paying it out to beneficiaries.
The reasons why a person making a Will may not want to distribute their estate immediately to beneficiaries are:
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Significant tax benefits are obtained using a testamentary trust, as minor beneficiaries can be taxed as adults. As the trustee has discretion over who is allocated the income, the distribution can be altered each year to get the best tax outcome. |
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Capital gains and franked dividends can also be streamed to a particular beneficiary to get the best tax outcome. |
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A testamentary trust can also be useful where the person making the Will wants to preserve the capital of the estate. The corpus (capital) of the trust is protected from the financial affairs of the beneficiaries. For example, if a beneficiary becomes bankrupt, the beneficiary’s share of the estate is protected and is not accessible by the bankruptcy trustee to meet the liabilities of the beneficiary. |
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Similarly, the corpus of the testamentary trust is not accessible in the event that a beneficiary becomes divorced. |
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The corpus of a testamentary trust cannot be accessed by beneficiaries who might be tempted to spend their inheritance without proper care. |
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A testamentary trust can ensure that the deceased assets are held for the children of the deceased and are not at risk if the surviving spouse remarries. |
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A testamentary trust can be set up to provide for the needs of a disabled beneficiary. |
Trustee
The control of a testamentary trust is directed by the Will of the deceased. The trustee can be an individual or a private trustee company. The actions of the trustee can also be limited by the Will, for example the trustee may be directed to invest or spend the estate in a particular way.
Alternatively, the trustee may be given discretion to act without specific restrictions, as long as the purposes of the trust are being met. In all cases, it is important that a trustee is chosen who will act in the best interests of the beneficiaries.
Appointer
The Will can be structured so that the surviving spouse is the appointor of the testamentary trust. This means that the surviving spouse has a choice to take the inheritance in the normal way or to put the inheritance into a testamentary trust. If the surviving spouse is the appointor, the appointor can also determine who the trustee of the trust is. The appointor can also determine when the trust will cease to operate and when the corpus is to be distributed to the beneficiaries.
Tax Advantages
The tax advantage of a testamentary trust is demonstrated in the following example.
Assume a husband died and left an estate of $500,000, and was survived by a wife and two children under 18. The funds are then invested with a 7% return in the 2010 financial year. This gives an income of $35,000 in that year. If the wife had received the full amount and invested it her own name, her tax bill would be $11,025, assuming a 30% marginal tax rate. If a testamentary trust had been used, the income could have been split between the children, but taxed at adult tax rates. The tax liability would therefore be $750, a potential tax saving of $10,275 a year.
The actual tax benefit will depend on the number of family members, particularly children under 18, and the size and structure of the estate.
Closing the Trust
Depending on the terms of the Will, the testamentary trust can end:
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When the surviving spouse dies, |
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At the discretion of the appointer named in the Will, |
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At the end of 80 years. |
The remaining capital will then be disbursed to beneficiaries in accordance with the instructions in the Will or at the discretion of the trustee.
Altering your Will
If you wish to alter your Will to enable a testamentary trust to be established, you will need to contact a legal advisor. Saward Dawson can work with your legal advisor to determine the tax implications of altering your Will.
Published : September 2011