Testamentary Trust Wills

Most wills give assets to beneficiaries outright. The gift is made, the executor transfers it, and the beneficiary owns it personally from that moment. A testamentary trust will does something different. Instead of the gift passing directly, it passes into a trust set out in the will, to be held and applied for the beneficiary rather than owned by them.

When it arises and how it operates

The trust does not exist while you are alive. The will contains its terms, but nothing happens until death, and until then the will can be changed like any other. On death, the executor administers the estate and the assets directed into the trust are transferred to the trustee of that trust rather than to the beneficiary personally.

From that point it operates much like a family trust. A trustee holds the assets, a class of beneficiaries is capable of benefiting, and the trustee decides who receives income and capital and when. The difference is that the terms were fixed by your will, and the trust typically exists for a single family line rather than for the whole family.

Who controls it, and who can benefit

Control is the point most often glossed over. A testamentary trust will usually names a trustee, frequently the intended primary beneficiary, and often gives that person or someone else the power to appoint and remove the trustee. How those roles are allocated determines how the trust actually behaves:

• If the primary beneficiary is also the sole trustee and controller, the trust is flexible but its protection against some claims is weaker.
• If an independent trustee or an external appointor is used, the protection is stronger but the beneficiary must deal with someone else to access their inheritance.
• Where the beneficiary is young, vulnerable, or at risk, control can be staged so that it passes to them over time or on conditions.

The beneficiary class is usually drawn around the primary beneficiary: their spouse, children, grandchildren, and often related companies and trusts. Drawing it too narrowly removes the flexibility that justifies the structure. Drawing it too widely can create problems of its own, including inadvertently including foreign persons where land is involved.

Asset protection

An outright inheritance becomes the beneficiary's own property. It is available to their creditors, forms part of the pool in a family law dispute, and passes under their will. Assets held in a properly structured testamentary trust are not owned by the beneficiary, which can change each of those outcomes.

Two qualifications matter. Protection is not absolute: a court can take account of a beneficiary's control of and access to a trust, particularly in family law, so a trust the beneficiary wholly controls offers less than one they do not. And protection depends on the trust being administered as a trust, with real decisions, proper records and assets kept separate. A trust run as though the money were the beneficiary's own invites the argument that it is.

Tax considerations

The tax features are a genuine advantage in the right circumstances, and they are frequently overstated in marketing material.

• Income can be spread. The trustee can distribute income among the beneficiary's family rather than having it all taxed to one person at their marginal rate.
• Minors are treated differently. Income of a testamentary trust distributed to a minor can be taxed at ordinary adult rates with the benefit of the tax-free threshold, rather than the penalty rates that otherwise apply to children's unearned income. That treatment is subject to rules about the assets producing the income, which is why the trust should be funded from the estate rather than topped up later.
• Capital gains and franked dividends retain their character when distributed, so the concessions available to the receiving beneficiary generally remain available.

The benefit is real where there are children or grandchildren and meaningful investment income. It is negligible where the inheritance is modest, or is to be spent rather than invested.

When it is not worth it

A testamentary trust has ongoing costs. It needs a trustee who will actually act, a tax file number, annual returns, and distribution decisions made and recorded each year. That burden is worth accepting in exchange for protection and tax flexibility, and not otherwise.

We would usually advise against one where the estate is modest, where the beneficiaries intend to use the inheritance immediately, where there is no realistic creditor or relationship risk, or where nobody in the family is willing to administer it. We would usually recommend considering one where a beneficiary is a business owner, in a profession with exposure, young, in an unstable relationship, receiving a substantial inheritance intended to stay in the family, or unable to manage money themselves.

How it fits the rest of the plan

A testamentary trust only controls what the will directs into it. That makes it one part of a plan rather than the plan itself. For clients with structures, the trust has to be read together with:

• the family trust, and who controls it after death
• superannuation, and whether the death benefit is directed to the estate so that it can flow into the testamentary trust, and what that costs in tax
• company shares, the constitution, and any shareholders agreement
• loan accounts owed to or by the deceased
• the risk of a family provision claim against the estate

Directing superannuation to the estate to fund a testamentary trust is a common and useful strategy, but it is not automatically the right one. Whether it is depends on who the dependants are and how they would otherwise be taxed on the benefit.

This page is general information. It is not legal or tax advice, and your own circumstances will change the answer.