Tax minimisation and asset protection: Do I need a testamentary trust?

The majority of Wills are “simple” Wills because the named beneficiaries receive their inheritance directly.  For many people, simple Wills are appropriate.  However, the circumstances of some clients will warrant more complex Wills which contain testamentary trusts.  The driver behind that may be tax minimisation, or a need to protect the estate assets.

1. What is a testamentary trust?     

A testamentary trust is a trust created by a person’s Will. A testamentary trust only comes into effect after the that person has died.  Where there is a testamentary trust, the beneficiaries do not receive their inheritance directly.  Rather, their interest is held for their benefit (“on trust”) by a trustee.  Unless the primary beneficiary is vulnerable in some way, generally they will be eligible to be the trustee of the trust (and in control of the decision-making).

2. How does it work?

There will generally be separate testamentary trusts for each primary beneficiary.  For example, each child of the testator would maintain their own trust.  The trustee then uses their discretion to distribute income to the primary beneficiary and a broad class of potential beneficiaries.  The potential beneficiaries are usually relatives of the primary beneficiary, such as children, grandchildren or spouses.

3. Why use a testamentary trust?    

A testamentary trust allows the primary beneficiary to minimise tax. If the primary beneficiary received their inheritance directly (without the use of a trust), the income generated would be added to the primary beneficiary’s personal marginal tax rate.  Testamentary trusts allow the trustee to decide how to distribute the income, a decision which is guided by the varying marginal tax rates of the potential beneficiaries.  This allows for the funds to be distributed in a way that minimises tax. Testamentary trusts are particularly advantageous where potential beneficiaries are minors.  The tax legislation permits income from testamentary trusts to be streamed to minors at adult marginal rates. Usually, as minors do not earn a large amount of income, the tax-free threshold and the lower marginal rates can be utilised to minimise tax. In contrast, where trusts are established during the lifetime of the testator (family trusts), limited income can be streamed to minors before penalty tax rates apply.    

Testamentary trusts also provide an element of asset protection.  This protection can extend to a primary beneficiary who is facing bankruptcy from creditors, and to a lesser extent, family law property settlements.  In the event of bankruptcy proceedings, provided the Will is drafted carefully, generally assets in the testamentary trust cannot be used to satisfy creditors.  In the family law setting, assets held in a testamentary trust are less likely to form part of a relationship pool available for division.

4. Creating a testamentary trust

Drafting Wills which contain testamentary trusts requires knowledge, skill and care.   If you are considering whether a testamentary trust is right for you, please contact our experienced Estates & Estate Planning Team at BAL Lawyers.

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