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What is a Testamentary Trust & Why You May Need One?

In the context of estate planning, you may have heard of the term testamentary trust. In this podcast, PD Law Senior Associate, Elizabeth Smith, explains what testamentary trust is and the circumstances it is often used.


Dan: Welcome to this edition of the PD Law podcast. In the context of estate planning, you may have heard of the term testamentary trust. Well, in today’s podcast, I’m with PD Law senior associate Elizabeth Smith, and we’re doing a deep dive into what they are and the circumstances that they’re often used. Elizabeth, what are the benefits of setting up a testamentary trust in your will?

Elizabeth: Testamentary trust can save you tax, they can protect your inheritance from potential divorce or bankruptcy risks, they can protect what we call immature, but beneficiaries who are under 18, and they can provide some relationship protection. So by that, I mean, if you are in a blended family and you’ve got some children from a previous relationship, or your partner has children from a previous relationship, it can provide some protections in that regard as well.

Dan: So you mentioned asset protection. What do you mean by that?

Elizabeth: Well, the discretionary nature of the trust is what assists with asset protection, because the beneficiaries of the trust don’t own the asset. They only have the right to be considered by the trustee, the trustee is the one who’s pulling all the strings in that regard, so it’s really hard for someone, an outside person to argue that the assets of the trust belong to that beneficiary.

So that provides the asset protection, so if you’re in a high risk position, if you’re likely to be sued, like a lawyer or an accountant, perhaps, or you run a business or you’re a director of a company, and you may be open to those risks, then you being the beneficiary of assets can really… It adds a layer of protection so that those assets can’t be clawed back into something if it all goes wrong for you, or if it all goes wrong for those beneficiaries.

I should say, same with family laws, so if a beneficiary of that trust is with someone and they then separate and they’re going through a property settlement, there’s certainly an argument to be made that because they’re only the beneficiary that trust and they don’t hold any control, that those assets can be excluded from any property pool.

So that can be really appealing to people, especially people who have spent their whole lives building up their assets and want to give them on to their family and don’t like the idea of those assets, perhaps going out of the family and to other people through no fault of their own, basically.

Dan: Elizabeth, are there assets that are better suited than others for inclusion in the Testamentary Trust?

Elizabeth: No, not really, all assets are pretty, it’s really helpful to have everything in there. But if we give a guiding rule of thumb is that if there’s about $500,000 of assets available for investment, then that’s a trigger for you to even consider it.

So if you think about, by the time you add up your superannuation, and if you’ve got a life insurance policy, if you own not only a house, but maybe if you’ve got an investment property, it all starts to add up really quickly, and all of a sudden your estate is worth a fair bit and so it really is worth you considering whether a TDT is for you.

Dan: How does a discretionary Trust, I should say, operate after the death of the test data?

Elizabeth: It works just like any other discretionary trust. It just sits dormant until the test data dies. So then there’ll be an appointor who is the ultimate controller, who sets who can sack the trustee if the trustee isn’t doing what they need to do.

Then there’s the trustee who has the control of the assets themselves, and the trustee is the person who manages the day to day of the trust and manages the assets for the beneficiaries and in their best interests, and then there’s the beneficiaries who are entitled to receive the income and capital from the trust, but only at the trustee’s discretion.

The beneficiaries do not own the assets themselves so it’s owned within the trust the beneficiaries just receive, I suppose, the clue is in the name, they receive the benefit from those assets.

Dan: Are there any tax benefits in setting up a testamentary trust?

Elizabeth: Yeah, there’s really great tax flexibility with testamentary trust. It’s one of those environments where you can get really great tax treatment, and I think the logic behind it is because someone had to die in order for that benefit to arise.

So I think on that basis, the assets flow through the trust for tax purposes, and that means that the income that’s earned each year from investing the assets needs to be distributed to the beneficiaries, and they get that at their own marginal tax rate.

So they can choose who of the beneficiaries can receive the income, and that allows them to give income to beneficiaries who have lower tax rates. So beneficiaries under 18 are also treated like adults for tax purposes, which means they can receive about $22,000 tax free each year, so if you think about it, if you were to die and you had a TDT set up and you had three children under the age of 18, you could distribute about $66,000 tax free to those children that would pay for their schooling, their health expenses and all of that and that’s before tax.

Whereas if you don’t have that, you’d be paying their expenses, but you’d be paying it out of your income after tax. So there’s real actual great benefits to that, to having a TDT.

Dan: With the upsides comes some downsides, of course. What are those in respect to testimony trusts?

Elizabeth: I suppose it comes down to admin, and it needs to be managed like any other trust. So you’d have to do the general, you have to do tax returns and have it managed. But other than that, there’s honestly not a lot of drawbacks to having a TDT.

If you’ve got a fairly decent asset pool and you want to give your kids those asset protection tax benefits, if the only problem is that they might have to talk to their accountant once a year, which they’re probably doing anyway, there’s not a lot of drawbacks to having one.

Dan: So practically speaking, how does a person that might be listening to this podcast start the conversation with you about Testamentary trusts? Does it come in the form of estate planning generally, or is it something else that jumps out in their day to day life, do they think, Oh, hang on, I should be looking at this?

Elizabeth: If they are talking to their accountant, their financial planners, their lawyers, their team, I suppose, they should be thinking about it, an estate planning is so important to be live to. Whenever you acquire an asset, if you buy a house, whenever you have a change in your family situation, if you get married, or if you have children, you need to be thinking about your estate planning and so it’s definitely not a set and forget.

But if you come and seek advice from a professional, they can probably, they can guide you through the process and give you some advice about what your options are and what best suits you to make sure that, how you envision it happening actually happens when you die. Because unfortunately, you’re not there to make sure it happens that way. So you need to engage professionals to make sure that how you want it to happen is how it happens effectively.

Dan: And obviously, people can reach out to you and others at PD law?

Elizabeth: Absolutely.

Dan: Elizabeth, thanks for joining me.

Elizabeth: Thanks.

Disclaimer: This podcast has been transcribed using AI. There may be errors that were lost in the translation.