What is a Testamentary Trust?
A Testamentary Trust is a form of discretionary trust that only occurs upon the testator’s death. It allows the trustee of that trust greater discretion in relation to both the control and distribution of assets within the trust to its beneficiaries.
The Advantages of a Testamentary Trust
In normal circumstances, special taxation rules apply to income received by minors. A higher tax rate will be imposed on a child’s income to deter income-splitting arrangements unless the child has earned their income through their own efforts. However, minors receiving income under a Will or a testamentary trust are entitled to be taxed at an ordinary marginal rate as if they were adults.
If a child takes an inheritance in the trustee’s name, then the income generated from the inheritance will be taxed at the normal rates of marginal tax, which apply to other income. However, if the inheritance is made under a discretionary testamentary trust, then the trustee can distribute income and capital to the trustee and the trustee’s children and grandchildren, which allows your children to benefit their children without incurring a tax liability in their name.
In simple terms, each trustee can use income from the funds held in the testamentary trusts for the maintenance, benefits, education and advancement of minor children. Any minors are considered to have received income, for which tax returns must be lodged. As the income is from a deceased estate, it will be taxed at normal marginal rates. The upshot of this is that the income can be split amongst the beneficiaries in a tax-effective way, such that the tax paid by the beneficiaries is at lower rates of marginal tax than that of the Trustee.
Flexibility of Management of the Estate
Wills can also provide flexibility to the trustees regarding the amount of the inheritance to be retained in the trust and the distribution of the income generated by the trust.
Firstly, discretion is provided to each trustee to decide whether to apply all or part of the inheritance to the trust or to pay all or part of the inheritance to the beneficiaries (including the trustee). This would, for example, allow part of the inheritance to be used to repay a mortgage while the balance is retained in the trust, allowing access to the taxation advantages outlined earlier.
Secondly, the trustee has discretion each year as to the distribution of income and capital and can make decisions based on the circumstances that arise from time to time. There is no obligation on the trustee to make the same distributions each year, and it is completely up to the trustee to decide how much to distribute and which of the beneficiaries to distribute it to. The only requirement is that the distributions must be made to the beneficiaries set out in the will – children and grandchildren. The beneficiaries have no right to demand distributions in their favour. The Trustee can distribute all the income and capital to the Trustee if they choose to do so.
The Protection of Estate Assets
The assets held in the estate under a testamentary trust are held by each trustee in a separate legal entity from the trustee’s assets. Accordingly, those assets are not exposed to any legal action against the trustee with respect to the trustee’s assets or actions. As the distribution to the beneficiaries is at the trustee’s discretion, if a beneficiary is exposed to liability or claims by creditors, then the Trustee may decide not to distribute to that beneficiary.
Jointly Owned Assets
Your will can only provide for the distribution and management of those assets which stand in the name of the will maker at the date of death. Assets that are jointly owned will pass to the survivor and will not be subject to the provisions in the will of a deceased joint owner.
Legal Professionals in Victoria
If you are seeking more legal advice, whether it pertains to a deceased estate administration, testamentary trust or similar, feel free to contact McNab McNab & Starke today. You can send us an online enquiry or give us a call to make an appointment at your nearest firm in Victoria.