What is a Testamentary Trust?
A will creates a testamentary trust.
This trust becomes active after the death of the person (the testator) who created it.
You can use testamentary trusts for many purposes, such as:
- Protecting your assets from creditors and potential claims.
- Reducing tax liability.
- Estate planning to ensure that the distribution of assets aligns with the wishes of the individual who created the will.
In this guide, we’ll unpack what testamentary trusts are and why they’re useful. We’ll also cover who manages them and essential factors to consider when setting one up.
By the end, you’ll have a better understanding of these trusts. You’ll also see why they’re a crucial part of planning for the future.
Table of Contents
Key Roles in a Testamentary Trust
Testamentary trusts involve four critical roles: the testator, trustee, beneficiaries, and appointor. Let’s dive into what each role involves.
The Testator
This is the person who creates the trust. The testator will usually appoint a trustee and specify the terms of the trust in their will.
The Beneficiary
These are the people who benefit from the trust. Usually, they are your spouse or your children. There are two types of beneficiaries:
- Primary beneficiaries are specifically named by the testator in the trust deed. They are entitled to the income from the trust.
- General beneficiaries aren’t explicitly named by the testator in the trust deed. Instead, their definition comes from relationships or descriptions, like ‘the children of Mary Jones and their spouses’. The trustee has the discretion to grant these beneficiaries benefits from the trust.
Both beneficiaries benefit from the trust. But the primary beneficiaries have a greater or more immediate right to the trust assets and income than the general beneficiaries.
The Trustee
This person makes the daily decisions for the trust. They manage the funds and decide who gets them. It’s up to their discretion, but they must follow the trust deed rules. Sometimes, the primary beneficiary can also be the trustee.
The Appointor
This person keeps an eye on the trustee. They can even fire them if needed. Often, they are the same person as the primary beneficiary and trustee.
How Does a Testamentary Trust Work?
A testamentary trust is born from a will. Within this will, the creator assigns a trustee. This person manages the trust’s assets to benefit the beneficiaries.
The assets placed into this trust could span from cash and investments to property or business interests.
The trustee operates according to the guidelines outlined in the will, acting with the best interests of the beneficiaries in mind.
The trustee holds the reins of control on when and how to distribute income and capital to the beneficiaries.
Typically, such a trust has a lifespan of up to 80 years.
Benefits of a Testamentary Trust
Why set up a testamentary trust? There are many benefits.
Tax Benefits for Young Beneficiaries
If you have children under 18, testamentary trusts are very beneficial.
In Australia, children’s income is heavily taxed. But with a testamentary trust, it’s different. The trust treats the children’s income as if it were adult income. So, they get the same tax-free threshold as adults. That’s $18,200 they can earn without paying any tax. It’s a big help in supporting kids’ futures.
Testamentary trusts are an intelligent way to take care of loved ones. They provide control and peace of mind. Even after you’re gone, you’re still helping out.
Life Interest Benefit
The testamentary trust includes a special feature, the ‘life-interest’ benefit. A legal provision permits a person, known as the ‘life tenant’, to utilise an asset – like a property – even though they don’t officially own it.
This benefit is flexible. The life tenant can reside in the home, generate income, or liquidate it for aged care necessities if necessary.
In simpler terms, it means a beneficiary can use an asset, such as living in a house, without having the authority to sell it. This protective measure ensures the asset’s preservation while allowing for its practical use.
Asset Protection
Trusts can protect assets from creditors. They can also safeguard assets in a divorce. They can set money aside for education.
Trusts are good for protecting high-risk beneficiaries. This includes those with money troubles or addictions.
They can protect assets if a spouse remarries. They can help support children with issues.
And they can stop challenges to the will. Testamentary trusts offer a lot of protection. They give you control over your assets, even after you’re gone.
Potential Drawbacks of Testamentary Trusts
Testamentary trusts may not always be the perfect solution. Here are some points to ponder.
Firstly, evaluate your assets. For smaller estates, establishing a trust may not justify the benefits.
If you already have a family trust, it’s important to understand how a testamentary trust could potentially interfere or conflict with it. Normally a family trust’s assets won’t go via someone’s will.
Next, there’s the financial aspect. Maintaining a trust comes with its own expenses. It may also have implications for your superannuation.
Like wills, trusts can also be disputed. This can trigger potential conflicts among the beneficiaries.
Pension eligibility is another factor to consider. The assets held in a trust could potentially impact your qualification for pensions.
Lastly, it’s crucial to remember that trusts are just a piece of the estate planning puzzle. They should align with a broader plan, which may encompass aspects such as superannuation, insurance, and other financial matters.
Establishing a Testamentary Trust
How do you set up a testamentary trust? First, it’s written into a person’s will. Next, after the person dies, the trust gets funded. This could be with assets or with payments from the estate.
But setting up the trust is just the start. Running it properly is important too. That’s called governance.
Good governance makes sure the trust works as it should. It keeps records straight and helps avoid disputes. And it makes sure the tax benefits are used correctly.
A well-run trust is a gift to your loved ones. It helps protect their future and make their lives easier. Trusts take a bit of work to set up and run. But the benefits are well worth it.
Summary
Testamentary trusts are powerful tools for protecting assets. The will creator sets them up, and they start after the person dies.
They hold assets like cash, property, and investments for the beneficiaries. Trustees manage these trusts, following instructions in the will.
Testamentary trusts offer many benefits. They provide asset protection, life-interest benefits, and tax advantages. They can also help support underage beneficiaries with a tax-free threshold. But they need careful planning.
Trusts can be costly to run and might affect pensions and other trusts. In short, testamentary trusts provide control and peace of mind for your loved ones’ future.
Ready to learn more?
Check out our guides, for more information covering Family Trust benefits:
- What is a Trust Deed?
- What does ATF trust mean?
- What Is the Settlor of a Trust?
- How Much Does it Cost to Set Up a Trust?
