An Overview of Testamentary Trusts
There are many vehicles by which a person’s estate planning needs can be fulfilled. One of the many approaches taken in estate planning is the creation of a testamentary trust. Below is a brief overview on this estate planning vehicle.
What is a testamentary trust?
In simple terms, a testamentary trust is created through a person’s Will and is an arrangement that entails a person – the trustee – holding particular assets for the benefit of another – namely the beneficiary – as per the terms set out by the trustor of the trust, until a certain time. Following on from the above definition, there are several parties involved in a testamentary trust:
1. The trustor – This is the person who elects to create the trust.
2. The trustee – This is the person who administers the Will as per the instructions in the Will.
3. The beneficiary or beneficiaries – This is the person or people who will receive the assets held by the trust.
4. The appointor – This is the person with the capacity to remove and appoint a trustee.
The previously mentioned ‘particular assets’ may include anything accumulated for the estate of the trustor in the course of their lifetime (e.g. investment properties), or assets attained as a consequence of the trustor’s passing (e.g. the proceeds from a term life insurance policy).
It is not until the death of the trustor that the trust is in effect, and how the trust is in effect is dependent upon the terms outlined in the Will. However, it is important to note that a testamentary trust may be of the discretionary type and consequently the distribution of the assets is at the trustee’s discretion, and may not necessarily reflect the contents of the Will. Furthermore, given that the appointor has the capacity to remove and appoint a trustee, it would be wise to nominate a ‘third party’ as the appointer to ensure impartiality in the appointment of the trustee and the distribution of the assets.
So why create a testamentary trust?
There are various reasons why an individual chooses a testamentary trust over other estate planning vehicles, and the reasons largely relate to personal circumstances, tax advantages and asset protection. The reasons for establishing a testamentary trust are largely associated with the advantages this vehicle affords a beneficiary.
Reasons for a testamentary trust
Tax advantages – In the case of a discretionary testamentary trust any inheritance received and placed in the beneficiary’s personal name is taxed at the beneficiary’s marginal tax rate. Therefore, it would be advantageous to direct the majority of the benefits to the beneficiaries with the lowest marginal tax rates. Furthermore, unearned income (this is inclusive of benefits received via a testamentary trust) that is distributed to minors is taxed in the same way as a benefit received by an adult beneficiary i.e. according to marginal tax rates, and bypasses the higher tax rates applied to this type of income when it is received via a family trust for example. It is also subjected to a higher tax-free threshold.
Asset protection
The acquisition by the beneficiaries of the testamentary trust assets is also controlled by the trustee. This is particularly advantageous when the beneficiary is a minor, is disabled or is incapable of responsibly managing finances for some reason e.g. a person with a gambling addiction. For the purposes of asset protection, a trustee can choose to:
• Gradually release the assets to ensure that the inheritance is not squandered.
• Only release the assets in the event they are to be utilised appropriately - for example, if they are to be used as payment of substantial medical bills.
• Only release the assets at such a time that the beneficiaries are deemed responsible enough to manage their own inheritance – for example, after reaching a certain age.
Personal circumstances
Testamentary trusts are also particularly useful in the event a beneficiary is likely to experience a relationship breakdown. Any inheritance held inside the trust is in the name of the trust and therefore is unlikely to be distributed to a beneficiary’s former spouse as part of a settlement.
The same reasoning applies to a beneficiary in financial difficulty – the inheritance cannot be distributed to creditors, unless this is the wish of the beneficiary.
Disadvantages of a testamentary trust
There are considerable costs involved in the administration of a testamentary trust that may well minimise the benefits from the tax advantages. If an independent trustee is appointed, there will be fees for the provision of this service. Furthermore, there are other fees such as the accountancy fees involved in the filing of tax returns for the trust.
Also, in trying to minimise the tax paid on the benefits of the testamentary trust by directing the majority of the benefits to the beneficiaries with the lowest marginal tax rates, it may be at the cost of directing the appropriate amount of funds to the desired beneficiary.
There is also the risk that the appointer and/or the trustee may not carry out their duties according to the wishes of the trustor.
To summarise, while testamentary trusts have considerable advantages, especially if the beneficiaries are minors, it would be wise to consider an individual’s circumstances to ensure the estate planning vehicle chosen suits their needs and objectives.
This is obviously an area that requires specialist advice so please speak to us if you require further information on your own situation.
If you require legal services please call our In House Solicitor, Sarah Hatch on (02) 9411-4161 or email sarah@taurusfinancial.com.au
Securitor Financial Group Limited is not responsible for advice provided by Solicitor Sarah Hatch of Hatch & Associates Pty Ltd.