A testamentary trust is a type of trust that is created through a person’s will and takes effect upon their death.
It is a legal arrangement where the assets and property of the deceased person (known as the settlor or testator) are transferred into the trust to be managed and distributed according to their wishes.
The purpose of a testamentary trust is to ensure that the assets are protected and distributed in a structured and controlled manner, and allows the testator to have greater control over how their assets are distributed, even after their death.
A standard will and a testamentary trust will are both legal instruments used in estate planning, but they are used for different purposes and operate differently.
The primary difference between the two lies in the control of assets and how they are distributed.
A standard will is a legal document that describes how a person’s assets should be distributed after their death, and may also include instructions for the care of minor children or other dependents.
It becomes effective only after the person’s death and after it has gone through probate, a court-supervised process of validating the will and settling the estate.
Assets are directly transferred to beneficiaries upon the death of the individual, after probate. Once the assets are distributed, the executor’s role ends and beneficiaries have full control over their inherited assets.
A testamentary trust will, on the other hand, is a will incorporating a type of trust that is created within a will. It doesn’t come into effect until after the death of the person who has made the testamentary trust will.
The testamentary trust will contains instructions to establish the testamentary trust (or multiple trusts if required) and outlines its terms, including naming a trustee and identifying beneficiaries.
Unlike in a standard will, where assets are directly transferred to beneficiaries, in a testamentary trust will they are transferred into one or more trusts. Then, a trustee who is named in the will controls these assets and distributes the assets or income from the trust to the beneficiaries according to the trust terms set out in the will.
This structure can provide continued management of assets, protect beneficiaries from creditors and have tax advantages.
A testamentary trust will is commonly used to ensure the financial security and well-being of beneficiaries, such as family members or loved ones, and to minimize the impact of taxes and other potential liabilities.
This type of trust should be considered when the will-maker wants to maintain a level of control over the distribution of the estate after their death.
Some situations where a testamentary trust could be beneficial include:
There are several key benefits to a testamentary trust, including:
While testamentary trusts can provide significant benefits, they also come with some potential disadvantages including:
Yes, a testamentary trust can be contested, but it’s important to note that contesting a testamentary trust typically means contesting the will that contains it.
A person may be able to contest a will, and by extension, the testamentary trust, if they have standing to do so and can prove valid grounds for the contest.
Typically, a person has standing to contest a will if they are a named beneficiary in the will or a statutory heir that would inherit in the absence of a will.
Valid grounds for contesting a will in Australia include:
Setting up a testamentary trust in Australia requires careful planning and drafting within a will.
The process typically involves:
You should store your will safely and let your executor know where it is. It is usually possible to store it with your estate lawyer.
It is also a good idea to review your will regularly. Circumstances change, so it’s important to review your will and the provisions of the testamentary trust, especially when significant life events occur such as marriage, divorce, the birth of a child, or significant changes in your financial situation.
Our will lawyers are here to help you with all matters relating to testamentary trusts, from setting one up to answering any questions you have regarding them.
If you wish to discuss a testamentary trust matter, get in contact with our team today by pressing the button below:
The testator (the creator of the trust), can add or remove assets that will go into the trust by updating their will. However, once the testator has passed away and the testamentary trust is established, additional assets generally cannot be added to the trust by others.
The main reason for this is that the testamentary trust is irrevocable and its assets are intended to be the property that the deceased person had at the time of their death and specified in their will to be part of the trust.
It’s also designed to maintain certain tax benefits and protect the assets within it, which can be compromised if additional assets are added.
However, the trust, through the trustee, can acquire new assets over time from the income or profits generated by the assets within the trust (for example, through the purchase of new investment properties from rental income). These new assets would be considered part of the trust property.
Distributions from a testamentary trust to beneficiaries are generally considered taxable income, but how they are taxed varies based on a number of factors.
For adult beneficiaries, trust distributions are added to their other income and taxed at their marginal tax rates. They will typically receive a tax statement from the trust (an annual tax statement or a distribution statement) which outlines the income they need to declare.
For minor beneficiaries (children under 18 years old), one of the key benefits of a testamentary trust is that they can receive distributions taxed at adult marginal rates, rather than the higher tax rates that typically apply to unearned income of minors. This is a significant advantage over other types of trusts and can result in substantial tax savings.
Trusts are also required to pay tax on income that is not distributed to beneficiaries in a financial year, with the tax rate depending on the circumstances.
Yes, a beneficiary can be a trustee of a testamentary trust in Australia. However, whether this is a good idea or not depends on the specific circumstances.
When the trustee is also a beneficiary, it can simplify some aspects of trust administration because the trustee-beneficiary may have a better understanding of the needs of the other beneficiaries.
However, it can also lead to potential conflicts of interest, as the trustee may be tempted to manage the trust in a way that benefits them more than the other beneficiaries.
Furthermore, one of the main advantages of a trust structure is the separation of control and beneficial ownership. If the trustee is also a sole beneficiary, this separation does not exist, which could potentially undermine some of the asset protection benefits of the trust.
In general, a testamentary trust, like other types of trusts, can borrow money, but it depends on the terms set out in the trust deed (which, in the case of a testamentary trust, would be outlined in the will).
If the trust deed allows it, the trustee of a testamentary trust could take out a loan on behalf of the trust.
However, lending to trusts is often seen as higher risk by banks and other financial institutions, so the trustee would likely need to provide additional guarantees or securities.
Borrowing money in a testamentary trust can have implications for the trust’s tax position and for the beneficiaries of the trust. For example, interest on the loan would typically be a deductible expense for the trust, but repaying the loan could reduce the income available to distribute to beneficiaries.
Testamentary trusts may have to pay tax in some cases, and the beneficiaries of the trust are generally liable to pay tax on the income they receive from the trust. This is similar to other types of trusts.
The income that a testamentary trust generates and distributes to beneficiaries is generally taxable. The beneficiaries must declare this income on their personal tax returns. The income is taxed at the beneficiaries’ personal income tax rates, with the exception of minor beneficiaries (those under 18) who are taxed at normal adult rates rather than the higher tax rates usually applied to unearned income for minors.
If the trust generates income in a financial year that is not distributed to beneficiaries, the trust is typically required to pay tax on that income. The rate can be quite high, up to the highest marginal tax rate.
The trust may also be subject to capital gains tax (CGT) if assets held within the trust are sold for a profit. However, beneficiaries may be entitled to certain CGT discounts.
The assets that initially fund the testamentary trust (i.e., the deceased’s estate) are not subject to income tax upon the establishment of the trust, although there may be capital gains tax implications.
While a testamentary trust itself does not go through probate, the will that contains the testamentary trust does, and the operation of the trust is usually dependent on the completion of the probate process.
Once probate has been granted for the will, the executor can then proceed with administering the deceased’s estate in accordance with the will, which includes transferring assets to a testamentary trust, if one is established by the will.
The testamentary trust itself begins operation after the death of the testator, typically once the probate process is complete and the assets have been transferred to the trust.
A testamentary trust lasts for a specific period of time as outlined in the terms of the trust, up to a maximum on 80 years. This is also known as the “vesting” or “perpetuity” period. Once this period is up, the trust must end, and the assets are distributed to the remaining beneficiaries.
The actual duration of a testamentary trust can be much less than this, depending on the terms set out in the will. For example, a testamentary trust might be set up to last only until a minor beneficiary reaches a certain age or achieves a certain life milestone, such as graduating from university or getting married.
The termination of the trust might also be triggered by a specific event, such as the death of a beneficiary.
A testamentary trust can be structured as a discretionary trust, depending on the testator’s intentions. However, it can also be structured as a different type of trust, such as a fixed or hybrid trust.
A discretionary trust is a type of trust where the trustee has the discretion to determine how the trust’s income and capital are distributed among the beneficiaries. The trustee has the flexibility to vary the amounts and timing of distributions based on the circumstances and needs of the beneficiaries.
The terms of the testamentary trust can include provisions that grant the trustee discretionary powers to distribute income and capital to the beneficiaries as they see fit. This allows the trustee to consider various factors, such as the financial needs, personal circumstances and tax implications for each beneficiary when making distribution decisions.
When the beneficiary of a testamentary trust dies, what happens to the trust depends on the specific terms outlined in the trust deed and the will that established the trust.
Some possible scenarios include:
A testamentary trust takes effect upon the death of the person who established the trust through their will (the testator). It does not come into effect until the testator passes away.
Upon the testator’s death, the executor of the will takes the necessary steps to obtain probate. Once probate is granted, the executor can begin administering the estate according to the terms of the will, including establishing and implementing the testamentary trust if specified.
It is at this point that the trust becomes active, and the trustee assumes control and management of the trust assets for the benefit of the named beneficiaries as stipulated in the will.
Anybody that the testator includes as a beneficiary in the testamentary trust can generally be a beneficiary, provided they meet the requirements outlined in the will and trust deed. The testator has discretion to determine who will be the beneficiaries of the testamentary trust.
The testator can specify individuals including family members, friends or even charitable organizations as beneficiaries of the trust.
In a testamentary trust, the settlor is typically the person who wrote the will and establishes the trust through their will (also called the testator).
The settlor outlines the provisions and instructions for the establishment and operation of the testamentary trust, including specifying the beneficiaries, appointing the trustees, defining the powers and duties of the trustees and determining the distribution and management of trust assets.
Yes, testamentary trusts are typically irrevocable, meaning they cannot be easily revoked or amended once they come into effect. Once the testator passes away, and the testamentary trust is established according to the terms outlined in the will, it becomes legally binding and difficult to alter.
The irrevocable nature of a testamentary trust is one of the key distinguishing factors from other types of trusts, such as discretionary trusts or unit trusts, which may allow for more flexibility in revocation or amendment.
However, there may be limited circumstances where a court could intervene to alter or revoke a testamentary trust, such as in cases of fraud, mistake or if the trust’s terms are found to be contrary to public policy.
In general, a testamentary trust cannot be dissolved once it has been established. Testamentary trusts are typically considered irrevocable, meaning they cannot be easily undone or terminated.
Once the testator passes away and the testamentary trust is formed according to the terms outlined in the will, it becomes legally binding and difficult to alter or dissolve. The trust continues to exist and operate until it reaches its specified termination date, if any, as outlined in the trust deed or will.
However, there may be limited circumstances where a court could intervene to alter or terminate a testamentary trust. For example, if the trust’s terms are found to be invalid, impractical, or contrary to public policy, a court may consider allowing modifications or termination.
To get in contact with us about your testamentary trust matter, either click the button below to call us or fill out the form and we will get back to you as soon as possible!