If you are looking to prepare a Will, the topic of ‘what is a testamentary trust’ is extremely important. Essentially, a party may wish to include a testamentary trust in a Will. Unlike traditional Wills that nominate beneficiaries for the assets, a testamentary trust transfers these assets into a trust.
The trust holds these family assets on behalf of a group of beneficiaries or a single beneficiary. When looking up about ‘what is a testamentary trust’ you may also come across the term “discretionary trust.”
Discretionary trust is a legal agreement. Through this agreement, one person holds and manages assets and trust capital on behalf of other people. The one who holds the asset is the trustee, and the one who they hold it on behalf of are the trust beneficiaries.
Although they may seem similar, there are some differences between ‘what is a testamentary trust’ and a discretionary trust. Before we look at these differences, let’s first understand the advantages of incorporating a testamentary trust.
What Is a Testamentary Trust: Advantages
Testamentary trusts are an estate planning tool that provides many benefits such as:
- control,
- asset protection,
- tax advantages, and
- preservation of government benefits.
One of the most significant advantages is that it allows the trustee(s) to control assets for up to 80 years, benefiting two to three generations. The trustee(s) can distribute the assets to the nominated beneficiaries at their discretion, which makes it flexible.
In terms of asset protection, a testamentary trust safeguards assets against claims from third parties. This is useful when a beneficiary is experiencing insolvency issues and creditors are claiming their inherited assets.
If the estate assets are distributed to and held by the trustee of a testamentary trust, the assets may be insulated from third-party claims against the individual beneficiary. The assets are held by the trustee for, and on behalf of the beneficiaries rather than the individual beneficiary.
Testamentary trusts also protect the inheritance of intellectually disabled beneficiaries, beneficiaries with illnesses, addiction problems or other weaknesses that could result in the loss or dissipation of an inheritance.
Taxation advantages of a testamentary trust include that children under 18 are taxed as ordinary taxpayers, commencing at the lower tax rates. This means that when compared to distributions made directly, or under family law trusts, there are considerable reductions in the total amount to pay tax when distributions are made to children and grandchildren until they reach the age of 18.
The capital gains tax realised on assets held by a testamentary trust can be streamed to one or more beneficiaries in a tax-effective manner.
Differences Between Testamentary Trust and Discretionary Trust
The main difference between the two is that parties can establish a discretionary trust during their lifetime, whereas they incorporate a testamentary trust in their Will and it comes into effect after the death of the testator.
There are some key differences between these two types of trusts. Here are some of the main differences:
- Creation: Parties create a testamentary trust through a Will. It comes into effect after the death of the testator. On the other hand, parties can create a discretionary trust during a person’s lifetime or as part of their Will.
- Purpose: A testamentary trust is typically used to provide ongoing financial support for beneficiaries, such as minor children, after the death of the testator. A discretionary trust, on the other hand, is often used to protect assets, minimise tax liability, and provide flexibility in distributing income and assets among beneficiaries.
- Control: In a testamentary trust, the trustee has a legal obligation to follow the instructions outlined in the testator’s Will. In a discretionary trust, the trustee has discretion over how to distribute the income and assets of the trust, within the parameters set out in the trust deed.
- Taxation: The tax treatment of testamentary trusts and discretionary trusts differs in some respects. For example, income distributed from a testamentary trust to a minor child is generally taxed at adult rates, while income distributed from a discretionary trust to a minor child is taxed at penalty rates.
- Termination: A testamentary trust typically has a fixed termination date, which is specified in the Will. A discretionary trust, on the other hand, can continue indefinitely, unless it is terminated by the trustee or by court order.
How to Choose a Trustee: Things to Consider
An important topic under ‘what is a testamentary trust?’ is understanding how to choose a trustee. Because they play such a vital role, you should carefully consider a few things before appointing a trustee. The trustee becomes the legal owner of the assets, and they have the authority to distribute assets from the Estate to the beneficiaries. People do appoint family members as trustee.
Given below is a list of factors that one must consider when deciding on a Trustee:
- Age
- Financial experience
- Whether they have time and resources to commit to managing the Trust
Moreover, if you wish to appoint more than one trustee, you have to consider whether each trustee is able to reach their decisions independently. You also have to consider if they are able to make their decisions jointly without any conflicts or serious disagreements.
Importance of Seeking Advice from Lawyers
There are numerous advantages of incorporating a testamentary trust into the Will. Majority of people opt to set up a testamentary trust in their Will if they have young children or children with a disability who would not be able to manage their inheritance. You can also create multiple testamentary trusts.
At JB Solicitors, our team of Wills and Estate Planning lawyers have a wealth of experience in dealing with a variety of matters. For simple and complex Wills, we also offer fixed-fee prices.
Matters related to ‘what is a testamentary trust’ can be complex and difficult to understand. This is why you should speak with lawyers who can simplify this for you. If you have question on capital gains tax, income tax or superannuation fund, contact our lawyers today.
Contact our team of solicitors today.
