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A Beginners Guide to Testamentary Trusts

Have you ever considered implementing a Testamentary Trust? Here's how it can help honour your wishes and care for your loved ones:

Sparing a moment to think about what life will be like when you're gone isn’t easy. It’s pretty tough to consider how your family will continue to be looked after and how your assets will be treated following your death. But implementing a clear and powerful estate plan ensures that your wishes will be honoured and your loved ones will be cared for when you’re no longer around. 

You may already be familiar with the benefits of a Will, but have you considered a Testamentary Trust? If you think Testamentary Trusts are only for complex estates or the very wealthy, they’re not – so read on!

What is a Testamentary Trust? 

A Testamentary Trust is an estate planning tool that is set up through your Will and only comes into effect once you’ve passed away. It is basically a discretionary trust or trusts contained in your Will to which your residue assets are distributed.  A Testamentary Trust can continue to operate for up to 80 years after your death, meaning that you can continue to provide for your family for generations and years to come. 

Through a Testamentary Trust, like other discretionary trusts, your assets are instead passed onto a named Trustee rather than your beneficiaries directly receiving assets and money. Your chosen Trustee will then control and manage your assets and distribute them accordingly among your beneficiaries. Testamentary Trusts hand over the reins to those you trust the most and allow them to honour your wishes. 

A common misconception is that Testamentary Trusts are only suitable for high-net-worth individuals and those entangled in complex financial situations. There are many benefits to a Testamentary Trust, including tax advantages, asset protection and peace of mind – so in reality, a Testamentary Trust is a useful tool for everyone to consider.

How is a Testamentary Trust Managed? 

Once a Testamentary Trust is established, your Trustee(s) have ultimate control over the trust and all the assets it includes. Your chosen Appointor(s) will also be able to remove, replace and nominate additional trustees to help manage the trust. Because of the power involved in managing a Testamentary Trust, it’s important that you select an individual or individuals to act as Appointors who you believe will continue to make decisions that accurately reflect your wishes when you’re no longer here. 

Unfortunately, a Testamentary Trust is not a set-and-forget solution. Once the trust comes into existence, there are fees and costs that are involved in order to successfully maintain the structure of the trust. These include costs associated with creating and lodging tax returns for the trust, and the costs in preparing financial statements for the trust or trusts. The costs incurred will vary depending on the value of the assets held within the Testamentary Trust. 

Tax Advantages of a Testamentary Trust 

One of the biggest advantages to a Testamentary Trust is that your Trustee has full control over any income, capital gains and other trust assets, and can decide how they are invested and/or distributed among your family and beneficiaries each year. Your Trustee also has the freedom to decide which of your beneficiaries receive the income, meaning that they can make distributions from the trust while taking full advantage of the beneficiaries with the most attractive marginal tax rates.

Beneficiaries who are receiving distributions from a Testamentary Trust under the age of 18 are exempt from the standard penalty rates that would usually apply to minors receiving income from a family trust. Instead, if an individual under the age of 18 were to receive income from a Testamentary Trust, they would be taxed at the ordinary marginal rates and would be able to take advantage of: 

  • the low-income tax offset and
  • the tax-free threshold. 

It’s also important to note that the trustee is not required to pay income tax on any income that is distributed to the beneficiaries unless as a proxy for a minor or where income is accumulated.  

Using Testamentary Trusts for Asset Protection 

You can provide your chosen beneficiaries with the option to choose whether or not they receive their inheritance directly into their own name. This means that any assets they inherit are protected from any existing (and future) creditors, as the assets are not owned personally by the beneficiary and, therefore, are not included in the beneficiary’s personal estate. 

Through establishing a Testamentary Trust in your Will, you ensure that your beneficiaries and their families will continue to benefit from the trust, despite any financial hardships they may experience (such as bankruptcy). The element of asset protection is particularly useful for beneficiaries who you may think are more financially vulnerable, or have faced financial difficulties in the past. 

Protecting Assets After a Divorce Through a Testamentary Trust 

As a parent, it’s only normal that you want the best for your kids. You may be concerned about what will happen to your child’s inheritance if they were to divorce from their spouse in the future. Would they lose their inheritance? Would it be split between them? 

Thankfully, with careful planning, you can minimise the risk of assets held in the trust from being divided on a relationship breakdown; although, for complete peace of mind a binding financial agreement under the Family Law Act 1975 is recommended. 

Getting Started with a Testamentary Trust 

Our BlueRock Melbourne-based lawyers and financial advisors offer a multidisciplinary approach to creating an effective Testamentary Trust. To establish a Testamentary Trust of your own, or to learn more about the process, get in contact with our BlueRock estate planning experts today. 

For more information, read our other articles on estate planning, estate planning mistakes and the advantages of testamentary trusts.

This article is intended as general information only and should not be considered as advice on any matter and should not be relied upon as such. The information in this article has been prepared without taking into account any individual objectives, financial situation or needs. You should therefore consider the appropriateness of the information in regards to these factors before acting, or seek advice before making any financial decisions.

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