A ‘testamentary trust’ is a trust established under a Will. The trust only comes into effect when the Will maker dies. The nature of this is to separate the legal ownership from the beneficial ownership. There are numerous benefits of a testamentary trust, as outlined below.
When assets are held in a testamentary trust the trustee has the discretion to distribute capital and income between a group of beneficiaries dependent upon the individual beneficiary’s circumstances.
Protection from Creditors
If a beneficiary of a trust is at risk of being made bankrupt or of being sued by a creditor then the trustee can ensure that distributions are withheld or made in a way to protect the inheritance from creditors and the Trustee in bankruptcy.
The assets held in a testamentary trust may be protected for the purposes of a family law property settlement if a beneficiary is in the midst of a relationship breakdown or it appears that the relationship may break down at a later stage.
Under taxation legislation, if gains of a testamentary trust are allocated to the beneficiaries then they are liable to pay tax at their normal marginal tax rates. Accordingly, the trustee can distribute gains to a member of the beneficiaries family who, in that year, have the lowest marginal tax rate.
Unlike other trusts, minor beneficiaries (those under 18) receive the benefit of the adult tax free threshold which in 2016 is $18,200.
As an example of the potential tax benefits available as a result of a testamentary trust here a typical family scenario:
John is 71 years old. He has left his entire estate in a testamentary trust. The value of John’s estate at the date of his death was $1.3 m and the primary beneficiary of the trust is John’s only child, Joanne. The other beneficiaries of the trust are Joanne’s children, Joanne’s grandchildren and Joanne’s great grandchildren.
Joanne is 49 years old and works full time as an Architect. Her taxable income last year was $150,000 per year and she has three children. Zoe who is 24 years old and works as a Pharmacist. James who is 20 years old and is studying to become a paramedic. David who is 15 years old and attends private school. Zoe has one child, Ella who is 2.
Zoe’s income was $46,000 last year. James works part time whilst studying and earnt $12,000 last year. David does not work and therefore has no income.
The income from the trust was $78,000. Joanne is a trustee of the trust and decides to distribute the income of the trust for the benefit of her children and herself equally:
Instead of paying Zoe the amount Joanne decides to make the payment to Ella. Ella’s distribution is paid to Zoe as Ella’s legal guardian and is applied towards Ella’s nursery fees and upbringing. As Joanne is the legal guardian of David she is able to receive these funds against costs of David’s upbringing. As Ella and David have no other income they receive the first $18,200 of their payments tax free.
Dependent on James’ deductions he will receive at least the first $6,200 tax free. Joanne is liable to pay tax at her marginal rate for her distribution.
If Joanne received her inheritance from her father directly she would be liable for the tax on the whole of the income at her personal marginal tax rate regardless of whether or not she received the entire benefit.
Setting up a testamentary Trust
A testamentary trust is drafted within your Will and you can include more than one in your will. Whether it is appropriate to have more than one testamentary trust is dependent upon your individual circumstances.
If you would like to discuss setting up a testamentary trust, please contact us on 07 3284 7875 and we can arrange a combined appointment with one of our financial advisers and our referral Estate Planning Lawyer.