Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 588

The nuts and bolts of testamentary trusts

In an earlier article, I briefly analysed family trusts and discussed some of their benefits. This article will consider the role that testamentary trusts can play in a well thought-out estate plan.

Because this subject matter is so broad, I have made this article a ‘grab bag’ of things that readers might think about when considering whether a testamentary trust might have a place in their estate plan. Any decision to use testamentary trusts should be accompanied with bespoke legal, accounting and financial advice.

Family trusts v testamentary trusts?

Like family trusts, testamentary trusts provide an opportunity to separate legal control and beneficial ownership in assets owned within them. Unlike family trusts, which are created during lifetime, testamentary trusts are created by a will and only come into effect upon the death of the will-maker.

That difference aside, testamentary trusts generally operate within the same legal framework as trusts created during lifetime. But as we will see now, they require considerations and create opportunities that are unique and independent of family trusts.

How do testamentary trusts work?

A will incorporating a testamentary trust can be thought of as a simple will plus a trust.

Testamentary trusts therefore offer a will-maker an alternative to gifting assets in their wills directly to beneficiaries. Instead, they provide a will-maker the option to pass estate assets to a trustee to 'hold upon trust' for an intended beneficiary, pursuant to a trust structure.

The trustee can also be a beneficiary of the trust depending on the will-maker’s objectives in creating the trust.

By splitting ownership and control in assets after a will-maker’s death, testamentary trusts effectively allow a will-maker to exert a degree of control over how their assets are used from beyond the grave – referred to in this article as 'post-death control'.

Controlling from beyond the grave

'Post-death control' can be understood as the ability of a will-maker to impose 'checks and balances':

  • at the time that they draft their will;
  • on the administration of their wealth after their death;
  • to direct how assets are to be distributed to their ultimate beneficiaries.

There are several reasons why a will-maker might want exert control from beyond the grave. An example follows.

Protective testamentary trusts

Testamentary trusts can be designed to provide principally for a specified beneficiary, while also denying that beneficiary control over decisions made in relation to the inherited assets.

Such trusts are often termed 'protective trusts' or 'All needs protective trusts' and usually:

  • nominate a beneficiary for whose benefit the trust is to be administered (principal beneficiary);
  • include provisions (written into the will) elevating the interests of the principal beneficiary to paramount importance;
  • impose an obligation on the trustee to consult with the principal beneficiary from time to time.

Vulnerable beneficiaries can be protected by providing for them as a principal beneficiary through the testamentary trust but vesting control of the trust (and decisions that affect its income and capital distributions) to an independent trustee.

The use of protective testamentary trusts may be an option where a will-maker is concerned that an intended beneficiary is physically or mentally (or for any other reason) unable to take responsibility for the management of their own financial affairs.

A more nuanced approach can be adopted when appropriate. For example, a testamentary trust could provide a Principal Beneficiary with a degree of autonomy but require them to seek third-party approval before inherited assets are sold.

Beneficiary controlled testamentary trusts

Where a will-maker is not concerned about the vulnerability of a future beneficiary, testamentary trusts can also be utilised to promote asset protection and tax planning on the same basis that family trusts do.

In these circumstances, the will-maker may provide effective control of the testamentary trust to an intended beneficiary. This could take the form of appointing them as the initial trustee and appointor (the person who can hire and fire a trustee) of a testamentary trust.

Such a move could allow the person inheriting the assets to split control and ownership in their inherited assets in a manner that they choose. These testamentary trusts can be incorporated into a will on a basis that their use by the intended beneficiary is optional.

Trustee selection

One of the differences between family trusts and testamentary trusts is the person who instigates the creation of a testamentary trust never controls it. This is because it doesn't come into being until after the will-maker’s death.

What this means is that will-makers have to decide who will be in control of their testamentary trusts after their death. The choice of a future trustee can be a difficult one to make and is critical to the future administration of the trust:

Independent trustees can be difficult to locate and expensive to engage. And where family members – such as a will-maker’s children – might be considered for the role, the family dynamic becomes an important factor.

It may be necessary, for example, to nominate one child over others due to intra-family relationships. The will-maker will also need to assess their children's respective skill sets.

Limitations of testamentary trusts

There are limitations associated with the use of testamentary trusts and with post-death-control.

The life of a trust

In South Australia, trusts can exist in perpetuity. In other states, trusts can exist for the perpetuity period – generally for up to 80 years (and 125 years in Queensland). Therefore in all states other than South Australia, there is a limit on how long post-death control can be exerted.

Trustee succession

With the passage of time, arrangements for ongoing trustee succession will be needed.

The tension between control and flexibility

Depending on a will-maker’s motivation for creating a testamentary trust in their future estate, a future trustee’s powers and discretions in administering that trust can be drafted to be anything from wide (even absolute) to non-existent.

If discretions remain active after a will-maker’s death, the creation of a testamentary trust shifts the focus of control from the will-maker (and the enforceable terms of their will) to the trustee and their successors (and the terms of the trust).

Removing or reducing the scope of discretions, and hardwiring trust distributions, enhances control of inherited assets but at the cost of flexibility, and potentially more advantageous financial outcomes.

Therefore there is always tension between the degree of post-death control that a will-maker is able to achieve and the flexibility of a future testamentary trust.

Reliance on future trustees

Unless trust discretions are completely hardwired, will-makers need to rely on future trustees to act appropriately in administering the testamentary trust.

There are also a couple of potential downsides:

  • ongoing administrative costs, which need to be justified relative to the benefits that are likely to be achieved
  • the necessity for a more complex (and therefore more expensive) will, and increased complexity in the future estate administration

Also, notwithstanding the potential tax benefits we outline briefly below, the taxation of trusts is complicated and, to a degree, uncertain.[1] In particular, the legislative framework dealing with the taxation of minors on income is complex, lacks clear judicial comment or consideration, and also lacks ATO guidance. A conservative approach accompanied by bespoke advice is warranted.

Advantages of testamentary family trusts

In addition to the advantages that family trusts generally offer, testamentary trusts currently offer a tax benefit that family trusts don’t.

The law of trust taxation is extremely complex and cannot be addressed fully here. But here is a glimpse:

  • in a family trust, any income distributed to a minor beneficiary in a single financial year in excess of about $500 is taxed at maximum marginal tax rates, and is therefore not commercially viable.
  • in a testamentary trust it is possible to distribute income from testamentary trusts to minors taxed at ordinary adult marginal rates[2] that include the tax-free threshold.

Despite some possible downsides, testamentary trusts are therefore a potentially valuable estate tax planning tool.

Case study

Leonard is a single man with two adult children aged 18 and 19. His assets include his business conducted though a corporate entity and substantial assets in his personal name. He wants to provide equally for his two children after his death but does not want them to be in complete control of their inheritance until the youngest is 30 years old.

Leonard has a good relationship with each of the children and they all get on well with each other. He holds a family meeting with the children, his solicitor and accountant to discuss options.

Leonard ultimately decides to make the asset protection and tax planning benefits of testamentary trusts available to his children. As a result, he executes a will that will creates a trust on his death in respect of all of his assets.

  • He appoints the two children and his accountant jointly as appointors of the trust.
  • He imposes restrictions on the sale of assets while the accountant is acting as appointor, with all trust decisions to be made unanimously between the two children and the accountant.
  • The accountant’s role will cease when the youngest child reaches the age of 30, at which time the children alone will control the trust and its assets.

Conclusion

Testamentary trusts can, in appropriate circumstances, offer benefits to a will-maker’s future estate and the ability to exert control over estate assets from beyond the grave.

An assessment of those benefits must be tempered with an appreciation of the complexity, and limitations associated with future trust administration and the challenges associated with identifying appropriate trustees.

As a result, the use of a testamentary trust should only be considered on a case-by-case basis and on the basis of professional advice.


[1] See for example the ATO’s preparedness to address the administration of testamentary trusts in accordance with the practices set out in PSLA 2003/12. Ultimately however that practice statement does not have the force of legislation but is an administrative statement to provide guidance to ATO staff.
[2] Advice should be sought on a case-by-case basis

 

Greg Russo is a succession law specialist and principal of Greg Russo Law.

Disclaimer

The information given by Greg Russo and Greg Russo Law in this article is given in good faith but is of a general nature only and it is not intended that this article will be acted or relied upon in the absence of individual legal, advice. Each person's requirements and circumstances will be different and accordingly, each person should engage professional assistance according to their own particular needs. Copyright in this document is owned by Greg Russo Law.

 

8 Comments
Greg Russo
December 02, 2024

David,

Thank you for your comments.

To pick up on one issue that you raised, the taxation treatment of Testamentary Trusts is complex and has been n impacted on by the Treasury Laws Amendment (2019 Measures No.3) Act 2020 (Cth) which received Royal Assent on 22 June 2020. The operation of Section 102AG(2)(a)(i) ITAA 36 now potentially creates estate planning challenges where a couple desire to create a common Testamentary Trust for their children under their Wills.
For example, where a husband predeceases his wife and assets of his deceased estate are transferred to his Testamentary Trust for the benefit of the children, the income generated on the transferred assets may be regarded as being Excepted Income (and available to be distributed to minors on a tax effective basis). When the wife later dies, if her assets are transferred to the Testamentary Trust established by the husband’s Will the income derived from those later transferred assets may not be regarded as being Excepted Trust income – because income will not have been generated on assets that were transferred to the Testamentary Trust by the deceased who had created that testamentary trust – being the husband.

Careful drafting and expert advice is always a good idea.

I also agree with your general sentiment regarding the general utilitiy of Testamentary Trtusts.

Greg Russo

Rob
December 01, 2024

I have provision for the establishment of separate Testamentary Trusts BUT it is not "compulsory" ie the Executors and Beneficiaries have some flexibility.

With "global children and global inheritance taxes" some flexibility is not a bad idea!

Steve
November 29, 2024

Thanks Greg for the article on what can be a complex area. My parents made provision for a testamentary (will) trust in each of their respective wills. The legacy that created is two separate will trusts with identical assets. The sensible approach is to merger the assets into one testamentary trust to reduce the future administrative burden; a reality that was envisaged at the time of will preparation. However, since July 2019, merging assets in this way jeopardises the concessional tax treatment for the potential minor beneficiaries (grandchildren) of the testamentary trusts. This seems a draconian measure given that the respective Wills state clearly that such a transfer is feasible. As always, when it comes to tax issues, the devil is in the detail!

Greg
November 29, 2024

Steve,

Thank you for your comment.

You are absolutely correct - the recent ATO measures call for a much more conservative approach

David Lunn
December 01, 2024

Steve, I don’t disagree re your comment about reduced administration however in most cases it’s worth it having multiple TT’s. Unless there is a compelling reason individual trusts are a way better solution. PS I’ve never seen this option of a single TT present itself as the best option. Thinking long term the inputs into the trust will be spouses, children, grandchildren etc. despite the trustee controlling things they are family members also. Professional trustees are very expensive and avoided if possible. NSW trustee and its ilk in other states should be avoided at all costs. At the early stages when there are only 2-3 siblings and they all get on things will be possibly ok. In the longer run it often ends in fighting, disputes, or at the very least dissatisfaction and resentment.

Not all beneficiaries will have the same idea about entitlements amounts nor timing of payments in excess of distributable income, taxation, personal goals and objectives not even ‘preserving the memory of the deceased’. Then there’s the consideration of the best investment strategy, can we loan money to the bene’s, capital distributions or not? I’m aware some of this is possible to include in a will but not in your case as it’s too late. However as the article intimates, control from the grave often leads to sub optimal outcomes as the cost is flexibility.

Simple organisation of accounts and assets drastically reduces admin. If you have $700k-$1m the cost is really acceptable. It creates the possibility for greater family harmony (whilst it’s not in the will almost all testators want this) and a good TT draft makes it non compulsory anyway, or can be wound up by the trustee if it’s no longer needed or wanted.

Personally, after the problems I’ve seen, I ALWAYS advocate for individual TT’s.

TT’s are an amazingly useful and powerful tool. (We haven’t even covered family law protection yet) and, in the right circumstances, are a strategic gem for accountants and financial planners to use for their clients.

Virtually nothing has all pros and no cons, you just need to figure out (with the right advice) what the best solution is for you and your own descendants.

Steve
December 01, 2024

Thanks David for your thoughts. Yes, in one sense, I appreciate the merits of individual TTs which is why my wife and I have ensured that our offspring have the option of inheriting through their own TT (to pick up on Rob's point). However, it would be simpler if the assets of the our marriage are able to be treated as one when it comes to intergenerational transfers. Instead, if the assets of the surviving spouse are to be passed down via a TT, those assets must form part of a TT separate from the TT established under the will of the first deceased in order to access the minor beneficiary tax concession. Each child is then left with two TTs to manage. Seems an unnecessary duplication.

Greg Russo
December 01, 2024

Hi David,

Thank you for your comment

All good points. Some relevant considerations that may mitigate in favour of a single Trust are - a desire for greater protection for the assets because no single beneficiary can ever be in control of their own assets - or the estate may contain assets that are unsuitable for transfer to multiple structures, such as business interests or “lumpy” property holdings. Also a single Testamentary Trust will have less ongoing costs than multiple Trusts.

However, a single Trust may result in conflict between beneficairies and challenges in the ongoing management of the Trust. It may also be preferable to consider separate Testamentary Trusts for each main beneficiary where they each live in different geographical areas, if they don't get on, if there is a benefit in keeping their future finances separate - and also where their respective risk profiles are different.

Greg Russo

David Lunn
December 02, 2024

Steve, that's not necessarily the case. With careful drafting you can have a TT in the first instance per child and when the second parent goes the same TT can be used. It's not a simple methodology regarding drafting but the outcome is massively better for exactly the concerns you raise.

The alternative is no TT in the first instance and only in the second. This is easier drafting but if the estate is material in value then the surviving spouse may pay unnecessary levels of taxation until they pass and the TT ultimately gets created.

@Greg for the additional cost if you have $700k+ the family harmony is a benefit, not a cost to have the multiple TT's. I would call it a family harmony insurance premium on the additional accounting costs. :-). Further if there are children (grandchildren of the deceased), definable interests are not a problem, or a minor one at worst, from an asset protection perspective. This is especially the case if you include trustee disqualification clauses for relationship breakdown, bankruptcy etc.

Also there are a large number of additional strategies. Say a client says I'll just pay off my mortgage, what do I need a TT for? What about, pay of the mortgage with a loan from the TT? We have additional family law protection for the now unlevered asset (to the bank), yes notional estate in NSW is still an issue. But say we manage to "save" our mortgage payments. Now we can "repay" the loan and invest in the trust. It's still a TT so minors get adult tax rates, even grand children ( great grandchildren of the deceased) can receive tax free income up to circa $20k or whatever it is these days.

TT's should be illegal they are so good, they are one of the most powerful financial planning and strategy tools. One per child is always best but ONLY when a TT is appropriate, as they aren't always appropriate in every case.

 

Leave a Comment:

     

RELATED ARTICLES

The nuts and bolts of family trusts

SMSFs and the control over estate planning

Wealth transfer isn't just about 'saving it up and passing it on'

banner

Most viewed in recent weeks

Vale Graham Hand

It’s with heavy hearts that we announce Firstlinks’ co-founder and former Managing Editor, Graham Hand, has died aged 66. Graham was a legendary figure in the finance industry and here are three tributes to him.

Warren Buffett is preparing for a bear market. Should you?

Berkshire Hathaway’s third quarter earnings update reveals Buffett is selling stocks and building record cash reserves. Here’s a look at his track record in calling market tops and whether you should follow his lead and dial down risk.

US election implications for investors and Australia

The return of Donald Trump to the US presidency brings the prospect of more US tax cuts and deregulation, but also more tariff hikes, trade wars and policy uncertainty. Here's what it means for markets going forward.

Avoiding wealth transfer pitfalls

Australia is in the early throes of an intergenerational wealth transfer worth an estimated $3.5 trillion. Here's a case study highlighting some of the challenges with transferring wealth between generations.

Taxpayers betrayed by Future Fund debacle

The Future Fund's original purpose was to meet the unfunded liabilities of Commonwealth defined benefit schemes. These liabilities have ballooned to an estimated $290 billion and taxpayers continue to be treated like fools.

The rising tension between housing debt and retirement balances

Australians are taking more mortgage debt into their 60s than ever before. Retirement planning assumptions haven’t adapted and could result in future income projections that ultimately disappoint retirees.

Latest Updates

Shares

Australian stocks will crush housing over the next decade, one year on

Last year, I wrote an article suggesting returns from ASX stocks would trample those from housing over the next decade. One year later, this is an update on how that forecast is going and what's changed since.

Superannuation

Addressing the gender super gap

The harsh reality is that most women retire with significantly less superannuation than men. There are many reasons for the gender super gap and here are some possible solutions to fix the long-running issue.

Superannuation

Meg on SMSFs: Where are the risks in our major super sectors?

Given the amount of money in super, it’s not surprising that there is a lot of focus on risk. SMSFs are often portrayed as the riskier option for the community as a whole, but does that tell the full story?

Superannuation

Global pension reforms and how Australia can improve

With plans to retire next year, Mercer's David Knox looks back at the global pension index he helped create, the key trends and developments since inception, and what Australia can to do to get better.

Shares

Cyclical stocks will drive markets higher in 2025

Magellan's Head of Global Equities, Arvid Streimann, thinks that although stock price momentum will slow next year, cyclical companies will lead the pack. He outlines the risks to his forecast and the stocks he likes best.

Economy

How this GDP per capita recession compares to history

GDP was 0.3% for last quarter but the real story is this was Australia’s seventh consecutive quarter of negative GDP per capita growth. How does this economic drought compare to past ones, and what can we expect in future?

Investing

The mispriced investment opportunity in global defence

Markets benefitted from peace for 40 years, but a military resurgence is now underway, fuelled by geopolitical tensions and technological advancements. Defence spending is soaring, offering potential opportunities for investors.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.