Estate planning can be a complex process that involves a lot more than just writing up a will. It often requires you to make difficult decisions to ensure your family is well taken care of in the event of your death. One of these decisions might include whether to set up a testamentary trust, but what exactly are they? And do you really need one for your will?
To help you out, we’ve put together a simple guide on testamentary trusts including how they work, the different types, as well as the pros and cons.
What is a testamentary trust?
A testamentary trust is a type of trust set up in your will that doesn’t come into effect until your death. It is designed to hold and protect a wide variety of assets including property, investments, and superannuation on behalf of a beneficiary or beneficiaries. It also affords you greater control of when and how your beneficiaries receive your assets.
A testamentary trust can last for up to 80 years and the will-maker can set up more than one testamentary trust. For example, a separate testamentary trust can be established for each beneficiary.
There are several situations in which a testamentary trust can be useful including:
- If one or more of your beneficiaries cannot manage your assets due to age or disability
- If one or more of your beneficiaries are in a high-risk profession (e.g. firefighter, police officer) or are susceptible to negligence claims, debt, or bankruptcy
- Take advantage of potential tax benefits and asset protection
How does a testamentary trust work?
A testamentary trust sees part or all of the grantor’s assets distributed to the beneficiaries specified. It is overseen by a nominated trustee who is the legal owner of the assets. The trustee is responsible for managing and distributing the assets in accordance with the will’s instructions. Whether it’s a spouse, family member, or friend, a trustee can be anyone that is over 18 years old and an Australian resident.
The grantor can either set out the terms and conditions for how the testamentary trust is to be managed or give the trustee full discretion.
Different types of testamentary trusts
There are many different types of testamentary trusts that can be included in a will, but the two most common ones are: discretionary testamentary trusts and protective testamentary trusts.
Discretionary testamentary trusts
A discretionary testamentary trust is where the trustee is given full discretion in distributing the capital and/or income to the beneficiaries. It is often used for asset protection and potential tax benefits. In a nutshell, the trustee gets to determine who gets what assets, when they will get them, and how much they will get.
Protective testamentary trusts
A protective testamentary trust is a trust that is established for vulnerable beneficiaries who aren’t able to manage their own financial affairs or are in need of protection. A vulnerable beneficiary might include someone with a disability, mental illness, addiction, spending tendencies, or who is in danger of bankruptcy. A protective trust sees the grantor nominate a trustee to control and manage the beneficiary’s assets to ensure they are used appropriately and passed on a needs basis.
Pros and cons of testamentary trusts
Want to know if including a testamentary trust in your will is right for you? Here are some pros and cons to consider when deciding whether to set up a testamentary trust:
|Tax benefits||With a testamentary trust, a trustee can distribute the income at their own discretion and split it in a tax-effective manner.
In addition, income distributed from a testamentary trust to a child or grandchild under 18 years old can be taxed at adult marginal rates, rather than penalty minor rates which are often quite high.
|Asset protection||One of the main reasons a testamentary trust is set up is to protect assets. This is because the assets in a testamentary trust are owned by the trust, not the beneficiary. Therefore, it is difficult for creditors to take the assets or for assets to be susceptible to bankruptcy or other legal claims.|
|Flexibility||One of the advantages of a testamentary trust is the flexibility to change it. You can change the terms of it whenever you want, to suit the particular circumstances and needs of your beneficiaries.|
|Expensive||A testamentary trust can be more expensive than setting up a simple will as it often involves ongoing, accountancy, operational, and legal costs per annum.|
|Complex||It is often more complex and difficult to establish and understand a testamentary trust than a traditional will. Before setting up a trust, you should make sure you fully understand how the testamentary trust will work.|
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Oiyo is a consolidated online resource, we are not financial advisors. We work with a range of industry professionals and compliance check our articles to ensure factual accuracy. However, we do not provide professional financial advice. Consider seeking independent legal, financial, taxation or other advice to check how the information and ideas presented in this article relate to your unique circumstances.