28th Sep 2012
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What is a testamentary trust?
Author: Rod Cunich
What is a testamentary trust?

Testamentary trusts are trusts created pursuant to your will once you pass away. In short, a trust receives your gift rather than your beneficiary. The benefits and mechanics of a testamentary trust are explained below.

Testamentary trusts are designed to provide maximum flexibility and allow for tax-effective distribution of capital and income as well as providing possible protection of an inheritance from third parties such as creditors.

When you pass, your lawyer and financial advisor will assist your executors determine how best to manage your estate for the benefit of your beneficiaries, taking into account risk management, taxation and other issues.

The inclusion of testamentary trusts into a will is not relevant to every situation but in many cases they offer valuable advantages over simple wills.

If everything is to be left to a single beneficiary:

Testamentary Trust will for three children:

The principal advantages of incorporating testamentary trusts in wills

1. Taxation Benefits [2]

Trust income distributed to children under the age of 18 is taxed at normal individual tax rates. Accordingly, there will be a tax-free threshold each year for each child. The current tax-free threshold is $18,200 (which will increase depending upon low income rebates), which is significantly higher than the tax-free threshold where distributions are made to children under family trust deeds. Where there are several children the tax relief can be very significant, particularly where there are a number of years until the children attain the age of 18. 

2. Capital Gains Tax [3]

Capital gains can be ‘streamed’ to one or more beneficiaries who are able to take better advantage of the five year averaging rule or CGT losses. Accordingly, the tax on capital gains ultimately payable on realised assets can be considerably reduced where one or more of the designated beneficiaries have a low income in the year of distribution.

3. Creditors Protection [4]

Under a normal will, if a beneficiary is experiencing solvency difficulties or is already bankrupt at the time of a distribution, it is likely the gift will end up in the hands of creditors rather than for the intended benefit of the beneficiary. This need not be the case where a testamentary trust is used, as the beneficiary has no actual entitlement to a distribution until the trustee so determines. Accordingly, assets can be retained within the family, free of creditor’s claims.

4. Family Law considerations [5]

A parent may wish to prevent a child’s spouse making a claim against the family assets in the event of marriage breakdown.  If testamentary trusts are used, a child’s spouse would ordinarily have no right to claim that a gift by a parent forms part of the matrimonial property which is to be divided. The Family Law Act does empower the courts to treat trust assets as matrimonial property but commonly the courts treat assets in a testamentary trust as a resource available to the spouse rather than matrimonial property - but this is not the situation in every case. It is an area where specific legal advice is critical.

5. Incapacity

In the event that a beneficiary is temporarily incapacitated, testamentary trusts will enable the assets to be managed by the family or professionals for the benefit of the beneficiary rather than having a portion of the estate controlled by an external agency.

6. Superannuation and Insurance Proceeds

Where testamentary trusts are used, the individual or his estate can be nominated as the beneficiary of superannuation or insurance proceeds. In this way, flexibility can be retained and the level of distribution to respective dependants, depending on the circumstances prevailing at the relevant time, can maximise the preferential tax status of the proceeds.

7. Flexibility

Discretionary testamentary trusts generally provide complete flexibility both as to the nature of the investments of the trust and as to the distribution of income and assets of the trust. Trusts can be validly created for up to 80 years [6] and, accordingly, can benefit two or three generations. Alternatively, the trusts can be dissolved at any time and distributions made to the desired beneficiaries. 


Notes

[1] The nature and extent of the available protection varies and is subject to changes that may occur in the law from time to time.  If this is an important aspect of your estate planning the issue of protection should be specifically addressed

[2] Subject of course to future changes in the law

[3] Subject of course to future changes in the law

[4] Subject of course to future changes in the law

[5] Subject of course to future changes in the law

[6] No time limit in South Australia


Talk to those who can help

If you would like more information about how Slater & Gordon can help you prepare a testamentary trust, contact Slater & Gordon by calling 1800 555 777





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