Testamentary (Family Will) Trusts

What are Testamentary Trusts?

Testamentary Trusts, also known as Family Will Trusts, are Trusts which come into effect after your death pursuant to the terms of your Will.

In contrast to ‘standard’ Wills, Wills which incorporate Testamentary Trusts can offer significant asset protection and taxation advantages, depending on your circumstances.

What are the advantages of Testamentary Trusts?

1. Asset protection

When an inheritance passes into a Testamentary Trust, it does not pass into a beneficiary’s personal name.  The Testamentary Trust can then protect an inheritance from being lost to creditors in bankruptcy or an ex-partner if a beneficiary is involved in family law proceedings.

Example 1:   If your child owns a business which suffers financial hardship and, as a result, your child becomes bankrupt, any inheritance they receive in their personal name can be lost.  If their inheritance passes into a properly structured Testamentary Trust, their inheritance can be preserved for their benefit.

Example 2:   If your child has separated from their partner and is in the process of a family law property settlement, any inheritance they receive in their personal name can be considered as part of their marital pool.  Alternatively, if their inheritance passes into a Testamentary Trust which is not within their sole control, that financial resource may not be considered as part of the marital pool and lost to or shared with the former partner.

2. Tax minimisation

Testamentary Trusts can be used to minimise tax by streaming income made by the trust to beneficiaries who may have lower incomes and therefore lower tax rates.

While this can be said of any discretionary family trust, Testamentary Trusts are particularly effective from a tax perspective where there are beneficiaries under the age of 18 years, such as grandchildren.  This advantage comes from the special treatment given to Testamentary Trusts which applies the adult tax-free threshold (indexed annually) to these minor beneficiaries, instead of the significantly lower threshold used for distributions to minors from other types of trusts.

Example 3:    If your adult child is the Primary Beneficiary of a Testamentary Trust and they have three young children; they can “stream” the income earned by their Trust to their children for essentials such as school fees, thereby bringing down the income earned by their Trust.

At present, the adult tax-free threshold is $18,200.00.  This allows a minor beneficiary to be entitled to up to $18,200.00 of tax-free income from a Testamentary Trust, which could be used to pay school fees, rather than added to their parents’ taxable income.

3. Protection of vulnerable beneficiaries

Testamentary Trusts can also provide you with confidence that the inheritance you leave is secure and protected, particularly where your beneficiaries:

(a)  Have a history of mismanaging their finances (for example, if they are inclined towards gambling or frivolous with spending);

(b)  Have an alcohol or drug dependency; or

(c)  Are otherwise vulnerable or at risk of financial or personal hardship.

If these circumstances apply, Testamentary Trusts can be structured in a way which ensures the beneficiary is not left in sole control of their Trust, which will ensure the funds held therein are preserved for their long term benefit.

Example 4:   If your child has a history of excessive gambling, directing their inheritance into a Testamentary Trust and including multiple Trustees as ‘controllers’ will ensure your child does not have unencumbered access to the funds held within the Trust, thereby ensuring it can be preserved for their benefit in the long term.

What is involved?

To take advantage of the benefits afforded by Testamentary Trusts, they must be included in your Will.  Your Will then provides the mechanism for the Trusts to be established after death.  Your Will also includes the following roles, which are essential for Testamentary Trusts:

1. The Primary Beneficiary

The Primary Beneficiary is, quite simply, the main person who will benefit from the Trust.  Who this is will depend on your circumstances, but ordinarily, this would be your spouse and then your children.

In addition to the Primary Beneficiary, a Testamentary Trust also has General Beneficiaries.  General Beneficiaries will often include the spouse, children, grandchildren, siblings, nieces and nephews of the Primary Beneficiary.  This wide definition ensures that the funds held by the Trust can be distributed widely.

In order to enhance the asset protection afforded by Testamentary Trusts, particularly if family law proceedings may be foreseeable, it may be appropriate to exclude spouses as General Beneficiaries.

2. The Trustee

The Trustee of a Testamentary Trust makes the “day to day” decisions regarding the Trust, including to whom funds are distributed and how funds are managed and invested.

It is important to note that beneficiaries of a Trust will not automatically receive distributions from a Trust, as these are subject to the Trustee’s discretion.  If circumstances are straightforward, the Primary Beneficiary and Trustee may be the same person, so distributions are straightforward.  If, however, asset or vulnerability protections are required, the Trustee may not be the same person as the Primary Beneficiary and therefore, distributions made for the Primary Beneficiary need to be authorised by the Trustee.

3. The Appointor

The Appointor of a Testamentary Trust oversees the work of the Trustee and is empowered to “hire and fire” the Trustee.

Again, if circumstances are straightforward, the same person may be the Primary Beneficiary, Trustee and Appointor of the Trust.  If circumstances require asset or vulnerability protections, the Appointor may be another person.

The greater the separation of these roles, the greater protections the Trust affords, but this needs to be balanced with what is practical and workable for individual circumstances.