Testamentary Trust In A Will

Testamentary Trust In A Will

Testamentary Trust In A Will

Testamentary Trust In A Will

A testamentary trust can protect inherited wealth, provide opportunities for tax benefits, and protect assets in a way a will can not. A testamentary trust can provide a long term financial legacy across generations and help keep hard earned wealth within the family.

Find out more about testamentary trusts, the benefits and why a trust may be a suitable option to protect your assets.

Let’s take a closer look.

What Is A Testamentary Trust?

A testamentary trust is established for beneficiaries after a person dies; it removes the need for them to own their inherited assets, which protects them from third parties such as bankruptcy, creditors, ex partners after a divorce. As well as protecting against third parties, it can also help preserve benefits for incapacitated, mentally ill or underage beneficiaries. 

A testamentary trust offers significant tax advantages and can provide income from the assets held within the trust, benefiting all beneficiaries. Multiple testamentary trusts can be contained under one will.

Testamentary trusts are managed by a trustee nominated by the person in their will. Selecting a suitable person to be the trustee is crucial to help ensure asset protection and beneficiaries receive entitlements per the trust’s directives.

Assets held within a trust can be removed, borrowed or used security, and unlike superannuation funds, access is more flexible. 

There are several types of testamentary trusts, and they can be set up to suit specific requirements and to protect the assets. 

Who Can Be A Trustee?

Anyone can be a trustee, family member, accountant, executor of the will or a close friend.

The trustee is entirely responsible for managing the assets of the testamentary trust; it is essential that the person nominated will act in the best interests of the beneficiaries and is competent and trustworthy. It is also crucial that the designated person is financially savvy, as they will be responsible for managing the investments. 

In some cases, appointing a trustee company or legal representative to manage the fund may be more suitable.

There is no requirement for assets to be equally distributed or accounts to be audited; the trustee of a discretionary trust has complete control. Careful thought must be given before deciding on a trustee, as sometimes people can be dishonest when controlling other people’s money. 

It is possible to nominate several trustees to manage the trust if in doubt. It is also crucial that a method for appointing a replacement trustee has been established to ensure the assets held within the fund continue to be managed effectively.

What Is The Difference Between A Testamentary Trust And A Will?

Wills are legal documents that outline who will receive someone’s assets when they die. The document states the beneficiaries, lists of assets and property and who will be the will’s executor. When a person dies, the estate assets are distributed according to the deceased’s wishes as stated in the will.

Conversely, a testamentary trust holds the assets without distributing them to beneficiaries upon the person’s death and is managed by a trustee. 

What Are The Benefits Of A Testamentary Trust?

Testamentary trusts provide numerous benefits to the beneficiaries, including; tax advantages, increased protection and control of the inherited assets, and greater flexibility.

Provides Flexibility For The Beneficiaries

When assets are held in a testamentary trust, the distribution becomes more flexible; they can benefit two or three generations. They are controlled by a trustee instead of the beneficiaries; the distribution may be adjusted as required, and they may only distribute part of the assets to the nominated beneficiaries.

Protects The Assets

There is a certain level of protection when assets are in a testamentary trust; for example, creditors or the spouse of a beneficiary cannot obtain the assets after a relationship breakdown. The deceased’s assets are held in a testamentary trust. They are protected against Family Law litigation and third party claims by creditors, as they do not form part of the beneficiary’s estate, which can be beneficial if they face bankruptcy or a relationship breakdown.

Assets held within a testamentary trust can continue to be preserved for up to 80 years, providing financial benefits across several generations.

Protects Against Irresponsible Beneficiaries

In some cases, a beneficiary may be irresponsible, unable to handle their finances or spend their share frivolously. A testamentary trust protects their entitlements as the trustee holds their assets until they can manage them independently. This can be particularly beneficial for children or intellectually disabled beneficiaries.

Provides Income Tax Benefits

Income, capital gains and dividends can be distributed amongst beneficiaries in the most tax efficient way, as there is no tax on any income that is distributed. The trustee can distribute the funds in the best way to affect their tax rates, ultimately benefiting each beneficiary.

When a person receives an inheritance from a deceased estate, they take the assets into their name and subsequently will be required to pay tax on the income generated at the top marginal tax rate. 

When the assets are in a testamentary trust, the income can be distributed to family members at a low tax rate; selecting beneficiaries on low marginal tax rates can minimise the trust’s tax liability. For example, dependent children can receive a pension from the superannuation as a source of tax effective income and avoid the penalty tax rates. 

Children under 18 years will receive considerable reductions in their total tax payable when receiving distributions under a testamentary trust compared to direct distributions or family trusts.

Leaving funds in a testamentary trust for educational purposes is more tax effective than leaving bequests to parents.

Avoid Stamp Duty And Capital Gains Tax Charges

Paying assets into a testamentary trust means that the transfer takes place within a will which means there are no stamp duty fees or capital gains tax applicable. When a capital gains tax is realised, it can be streamed into one or more beneficiaries to become more tax effective. Also, beneficiaries can defer selling assets until a more advantageous time, avoiding capital gains tax liability at an inopportune time.

Franked dividends can be distributed amongst all the beneficiaries annually in the most tax effective way.

Superannuation Fund Distribution Benefits

An accumulated balance of life insurance or superannuation fund can also be included in a testamentary fund, preventing them from being distributed directly when the person dies.

Setting up the life insurance policy or superannuation death benefits to fund the trust is also possible, avoiding taking administration costs from the asset pool.

When a superannuation death benefit is received by a tax dependent beneficiary, such as a spouse or minor children, the super death benefits will be tax free.

Easier Management For Incapacitated Beneficiaries

When a primary beneficiary is temporarily incapacitated, a testamentary trust allows the trustee to manage the assets instead of an external agency, which can be financially beneficial if the assets need to be managed for a short period. 

Testamentary trusts are also beneficial when the primary beneficiary has an intellectual impairment and a family member acting as the trustee can protect the family assets.

What Are The Disadvantages Of Testamentary Trusts?

When considering a testamentary trust, it is essential to be aware of the disadvantages involved; being prepared in advance for any issues that may arise is crucial.

Succession Issues

The trustee has ultimate control over the distribution and management of the testamentary trust; they can distribute any part of the income to the beneficiaries as they desire. The succession of the role of the trustee must be clearly stated in the will to ensure that the person taking over the function has the appropriate skills and capability to manage the assets effectively.

When a trust continues past the primary beneficiary’s death, it is also imperative that the second generation distribution of assets is considered, particularly if subsequent family members challenge the trust.

For superannuation death benefits to be tax free, the terms of testamentary trusts lineal descendants need to be very specific, tax concessions may not apply if assets are paid to anyone who was a non death benefit dependant. 

Trust Administration Costs

The main disadvantage of testamentary trusts is the administrative costs, such as accounting fees for preparing trust tax returns or fees from a professional trustee. The ongoing costs of managing the trust may outweigh the income generated, mainly if there are not sufficient assets within the estate.

Pension Eligibility

A beneficiary who receives a pension may be disadvantaged if they receive income from the trust, as it may affect their pension. Conversely, whilst the assets are held within the trust, the funds are not part of the means test when establishing initial eligibility for the pension.

Capital Gains Tax

If capital assets are sold at a loss, they can not be distributed to the beneficiaries and must stay within the trust to be offset against future capital gains.

How Do You Create A Testamentary Trust?

Testamentary trusts are created as a part of a will and become effective after death. There are several types of trust, and the structure can allow flexibility to be personalised to suit individual requirements. For example, a person may restrict the beneficiaries access and control of the investments, or they may hand over complete control. When establishing a testamentary trust, the terms are set; the correct terms must be stated, as asset protection should be a priority.

The most common type of trust provides complete discretion about the distribution of assets to beneficiaries. This will enable the trustee’s job to be straightforward as they can quickly identify the beneficiaries upon the person’s death and where the assets will be distributed.

It is also possible to create multiple testamentary trusts within a will or to give the executor the discretion to make good decisions on the deceased’s behalf. A testamentary discretionary trust allows the trustee to determine which beneficiaries receive capital or income from the trust and how much they receive.

The deceased’s family can also create a testamentary trust after the person has died to obtain the same tax benefits of income derived from the trust, but this will need to be made within three years after their passing.

A testamentary trust expires when a beneficiary receives the assets.

When creating a testamentary trust, the following points must be carefully considered;

  • Select a suitable trustee – ensure they are trustworthy. 
  • Establish beneficiaries – are their spouses or children included?
  • Restrict the type of asset distribution to beneficiaries – income or capital only.
  • Establish a method to appoint a replacement trustee – to continue to manage the assets held within the fund effectively.
  • Determine whether to have several trusts within the will.
  • Determine whether to have several trustees managing the fund – to ensure accountability and asset protection.
  • Ensure that succession issues have been established – to determine the future of the trust and when it ceases.

Legal advice must be obtained before creating a testamentary trust, as the trust should be a part of the total asset plan handled by a professional estate planning team.

Summary

Testamentary trusts are created as a part of a will and become effective after death. There are several types of trust, and the structure can allow flexibility to be personalised to suit individual requirements. 

Testamentary trusts can offer significant benefits to the beneficiaries, including; tax advantages, increased protection and control of the inherited assets, and greater flexibility.

A testamentary trust can protect assets against claims from third parties such as bankruptcy, creditors, or ex partners after a divorce. As well as protecting against third parties, it can also help preserve benefits for incapacitated, mentally ill or underage beneficiaries.

A testamentary trust expires when a beneficiary receives the assets. 

The trustee is responsible for managing the deceased’s assets held within the testamentary trust; it is crucial that the person nominated as trustee will act in the best interests of the beneficiaries and is competent and trustworthy.

Legal advice must be obtained before creating a testamentary trust, as the trust should be a part of the total asset plan handled by a professional estate planning team.

FAQs

What Are The Disadvantages Of A Testamentary Trust?

When considering a testamentary trust, it is vital to be aware of the disadvantages involved; being prepared for any issues that may arise is crucial.

Some of the main disadvantages include;

  • Succession issues – second generation distribution of assets must be considered
  • Administration costs – costs may outweigh trust income
  • Effects on pension eligibility –  payment can affect pension eligibility
  • Capital gains tax –  assets sold at a loss can negatively impact

Careful thought must be given before deciding on a trustee, as sometimes people can be dishonest when controlling other people’s money. 

What Is The Difference Between A Family Trust And A Testamentary Trust?

A family trust operates similarly to a testamentary trust, and assets are managed by a trustee or external party to ensure asset protection. The main difference is that a family trust is created and activated during a person’s lifetime. In contrast, a testamentary trust will only become effective upon a person’s death, as it is contained within their will. 

Testamentary trusts can offer significant tax concessions, particularly to children under 18. Instead of paying tax at the top marginal rate, they are taxed at a lower tax rate; compared to a family trust, a testamentary trust is a more tax effective method of distributing assets.

What Is The Difference Between A Will And A Testamentary Trust?

Wills are legal documents that outline who will receive someone’s assets when they die. The document states the beneficiaries, lists of assets and property and who will be the will’s executor. When a person dies, the deceased estate is distributed according to their individual wishes as stated in the will.

Conversely, a testamentary trust is a trust established under a will which holds the assets without distributing them to beneficiaries upon the person’s death. A trustee is responsible for managing the deceased’s estate held within the testamentary trust.

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