Testamentary Trusts - Taxation Benefits and Protecting your Assets

What is a Testamentary Trust?

A Testamentary Trust is a Will in which the person making the Will gives his or her spouse, partner, children or other beneficiaries the opportunity to receive their gift into a trust which is controlled by the beneficiary for the benefit of himself or herself and the family of the beneficiary.

The potential advantages of a Will containing a testamentary trust include:

• The ability to protect your family’s inheritance against claims by spouses and creditors (Asset Protection)

• The ability to maximise the benefit of your family’s inheritance by directing income to beneficiaries such as children and grandchildren who pay the lowest rates of tax (Taxation Benefits)

 Asset Protection

Assets may receive greater protection if held under a Testamentary Trust because the assets gifted to the testamentary trust can only benefit persons listed as beneficiaries.  A Testamentary Trust can protect assets in the following ways:

• Assets held within a Testamentary Trust may be protected against bankruptcy – this may be especially relevant for beneficiaries who are company directors or involved in highly leveraged businesses;

• Assets held within a Testamentary Trust may be protected in the event of a beneficiary becoming divorced and their assets being split in the divorce or de facto relationship breakdown;

• Assets held within a Testamentary Trust may be protected against children mismanaging or wasting their inheritance; 

• A Testamentary Trust may ensure that that the surviving spouse will pass on their assets to their children upon that person's death; and

• A Testamentary Trust may ensure that assets inherited by children pass onto grandchildren upon the child’s death (instead of other persons such as the child’s spouse).

Taxation Benefits

By using a Testamentary Trust, any income gains, capital gains and franked dividends earned from the estate assets after you die may be distributed among beneficiaries annually tax-efficiently.

Substantial tax benefits may be derived from section Section 102AG of the Income Tax Assessment Act 1936 (incorporated in the 1997 Tax Act).  This section removes the penalty tax rates on unearned income (interest, investment dividends, etc) for children under the age of 18 years and allows ordinary tax rates to apply where the income is distributed from a trust estate created under a person’s Will (ie, a testamentary trust). 

A practical and powerful outcome of this law is that income, including interest and investment dividends, distributed from a deceased estate to a child or grandchild aged under 18 years will be taxed as if he or she is an adult.  This provides an enormous advantage for the family because, assuming the child or grandchild is not otherwise earning income, during each year that the child or grandchild receives income from the deceased estate the child or grandchild will pay no tax whatsoever on the first $18,200 of income received for that year.  Further on income exceeding $18,200 the child or grandchild will pay tax at the lowest rates, increasing progressively depending on the amount of additional income received by the child or grandchild.

In recent years, after receiving appropriate advice, many of our clients have chosen the option of making a new Will containing a Testamentary Trust when updating their Wills.  In some cases the potential benefit to a family will be tens or hundreds of thousands of dollars over a period of years.

How to make a Will containing a Testamentary Trust

If you wish to make a Will providing for a testamentary trust or wish to obtain further information, please contact Sebastian Dimarco on 02 9037 1000.  

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