What is a Testamentary Trust?
A Testamentary Trust (sometimes called a Will Trust) is a discretionary trust which is created in your Will. A discretionary trust (when created during your lifetime is usually called a family trust) is where a person or company (trustee) holds property, business or investments on trust for the benefit of a number of people and related parties (beneficiaries). The trustee has the total discretion to distribute the income and capital of the trust to the beneficiaries. Creating a Testamentary Trust in your Will is often a more effective alternative than making a direct gift to a person under a standard Will.
What are its advantages?
By distributing income between beneficiaries, the trustee is able to manage the total income tax payable by the group.
For example, Peter dies leaving his dependant wife Mary, and three young children. In addition to the matrimonial home and other assets, he had a life insurance policy of $500,000. If this were invested at 8%, it would generate an income of $40,000 a year.
Scenario 1: Peter’s standard Will leaves the life insurance to Mary (assuming Mary has no other income to affect her rate of tax)
| Beneficiary Mary |
Annual Income $40,000 |
Tax Payable * $5,550 |
Scenario 2: Peter’s Will establishes a Testamentary Trust controlled by Mary
| Beneficiary Mary Child 1 Child 2 Child 3TOTAL |
Annual Income $10,000 $10,000 $10,000 $10,000 ______ $40,000 |
Net Tax Payable * Nil Nil Nil Nil _____ Nil |
With a Testamentary Trust, Mary saves $5,550 a year, every year, in tax. Keep in mind that the tax position for a family trust created during your lifetime is different, as not as much income may be distributed to children under 18 years without paying extra tax.
Protection from Divorce
If a beneficiary (say your child) separates and is involved in matrimonial property proceedings, it is possible by using the Testamentary Trust to keep your child’s inheritance separate from his or her own assets, and therefore quarantine it from a claim by the separated spouse. In this way, your estate is left to your direct descendants, rather than being divided between in-laws.
Protection from bankruptcy
If a beneficiary gets into financial difficulties, even though he or she may be bankrupt, the gift given to them via the Testamentary Trust will be protected from that bankruptcy. These days, when more and more people are involved in financial activities (such as giving guarantees for business, borrowing or investment etc) this may be an important protection for your surviving family.
Protection for a person suffering from incapacity
If a person develops some incapacity, such as an intellectual handicap, alcohol or drug dependency, or just may not be able to handle money, rather than give a gift directly to that person, you can have other people control it through a Testamentary Trust.
Exercising control of your estate
Although a standard Testamentary Trust has total flexibility so the trustee is able to invest in whatever property or assets they wish, and may draw on capital or income from time to time as they desire, you may wish to exercise some control over this. So, with a Testamentary Trust, the capital of the gift may be held ultimately for the children of the beneficiary so that while that beneficiary is alive, he or she has access to income only.
What assets are included in the Testamentary Trust?
Only assets that are in the deceased person’s name at the time of his or her death are included in that trust. Therefore, it is important that insurance policies and the ownership of jointly owned properties are reviewed by a lawyer to ensure that they will form part of the trust.
Sometimes it is preferable that superannuation money is received by surviving spouses or children, rather than being paid into a trust. It is appropriate to have options in your Will to enable superannuation funds to be paid either to the trust or to individuals.
