A testamentary trust can be a great way that people can protect their beneficiaries through their will and should form an important part of any good estate plan. They are quite popular as they allow people to have some form of control beyond the grave. There are many benefits to them but there are also things you should consider before putting them into your will.
What is a testamentary trust?
A testamentary trust is a type of trust that is named in the will and comes into effect upon death. The trusts are set up in order to hold assets and are looked after by a nominated trustee, who distributes the trust’s assets to beneficiaries. The manner in which the trustee distributes the assets depends on the type of the testamentary trust.
There are a number of different types of testamentary trusts, but two of the most common ones are:
Reasons to incorporate testamentary trusts in your will
Protection of assets
A major advantage of testamentary trusts is the protection of the assets. The assets are essentially owned and controlled by the Trustee meaning that this separation between who owns and controls the assets and the potential beneficiaries will protect the beneficiary to a degree if they were to be sued or become involved in any legal action.
Similarly if their was to be a breakdown of marriage between the beneficiary and their partner, the trust would provide far greater security than if the assets were held in the beneficiaries name.
If a beneficiary was to have financial difficulties such as bankruptcy, then the assets held by the trust can in some circumstances by protected from the potential creditors.
The degree to which the available protection will hold up varies and is subject to the changes that may occur in law, so you should ensure you get professional advice and make clear what you are seeking to achieve.
The Trustee is able to distribute the income, capital gains and franked dividends among all of the beneficiaries in the most tax efficient way possible. One of the main points with a testamentary trust is that minors are treated as adults from a tax perspective and are therefore able to benefit from the tax free threshold, low income rebates and varying tax brackets.
At risk beneficiaries
As mentioned above, a protective testamentary trust has the ability to protect potential at risk beneficiaries. An example of this may be a potential beneficiary that has a history of drug abuse and the person who’s estate it will be does not want to give them full control over the assets. The Trustee is able to drip feed some of the funds to the beneficiary in a way that the person who’s estate it was would have wanted. This can provide more certainty and also specify the purpose for which certain assets are used for.
Considerations of setting up a Testamentary Trust
One of the main considerations that people should look for before setting up a Testamentary Trust is to be aware of the potential tax implications of holding some assets in the trust such as the family home along with the taxation rules for superannuation death benefits if the trust beneficiaries are not confined to dependants.
Another thing that people should be aware of before setting one up is the administrative costs that are associated with having a trust. You need to make sure that there will be value for the costs that you are paying.
These considerations should form part of your broader estate plan. As always, you should seek professional advice and where appropriate, engage your beneficiaries to discuss why are you doing this so you are all on the same page.
Zac is a qualified financial planner at Pekada and host of the Wealth Collective Podcast. Living in Melbourne, Zac has six years of experience in advice and specialises in wealth accumulation and protection strategies. He loves to keep his finger on the pulse for the best strategies for wealth accumulators looking to build and protect their wealth tax effectively. Zac has been featured as an expert in Money Magazine.