Testamentary trusts aren’t for everyone. But they can solve a dilemma for some parents who want to leave their assets to their children and grandchildren with tax advantages or to protect their assets so they don’t fall into the wrong hands.
A discretionary testamentary trust is incorporated in a will by a lawyer and it doesn’t start until the person with the will dies. It is up to the will maker to decide which assets are held in the trust and who will receive them. Most importantly, the testamentary trust – not the beneficiaries – legally owns the assets.
Why bother to set one up? Rather than distributing assets to your beneficiaries via a will, a trust is worth considering if you are worried your kids could divorce, face bankruptcy or be sued. If you leave your kids money in a will, their spouse is typically entitled to that money.
“Those assets [in a trust] are protected from your beneficiaries’ creditors in the event of their bankruptcy or successful legal action against them,” says Anna Hacker, a lawyer specialising in wills and estates, and national manager at Australian Unity Trustees’ legal services.
Another reason to set up a testamentary trust is if your kids aren’t able to manage your assets after you die – for example, if they are addicted to substances or gambling, have lost mental capacity or are high income earners who could be taxed heavily on the income generated by the assets.
But for a testamentary trust to be cost effective to administer, Hacker says you need assets of around $400,000 to cover the accounting, legal and administrative expenses. The fees vary according to the size of the trust and the assets.
How it works
The will maker nominates beneficiaries, who are typically the spouse, children and grandchildren, and picks a trusted person to be the trustee or trustees. They don’t have to be a family member but can be a friend or even a fiduciary company.
When the will maker dies, the trust’s assets are transferred directly to the trustee (or trustees). The trustee has control of the trust and its assets but has to act within the rules of the trust deed that were set out by the will maker.
The trustee decides which of the nominated beneficiaries – often those with low tax rates – receive income and capital distributions each financial year.
A big advantage of a testamentary trust is that any income allocated to a child under 18 is subject to adult tax rates, including the $18,200 tax-free threshold.
Usually kids have to pay huge tax rates on unearned income. The table shows how families would pay no tax on the income distributed by the testamentary trust.
It also shows that if one of the sons faces bankruptcy, divorce or legal proceedings, the assets will be protected.
Hacker says testamentary trusts typically last for 80 years. She says beneficiaries will not have access to their parents’ or grandparents’ assets in the trust to liquidate and spend as they see fit.
“This can help ensure your assets are protected from beneficiaries who might misuse their inheritance because they are poor money managers. In so doing, you may be able to improve the preservation of your assets for the next generation. However, it is imperative the testamentary trust be drafted appropriately to ensure it is successful in protecting your assets.”