A testamentary trust is a trust that is established by the will and comes into existence when probate of the will is granted.
A testamentary trust can be established under a will for either specific assets or for the residue of the Estate (after debts and making all other specific gifts).
The will becomes the trust deed for the trust.
Where a testamentary trust is established, there are various requirements that a Testator must comply with. For example, in NSW, the Testator must comply with the formal requirements contained in Section 7 of the Wills, Probate and Administration Act, 1898 for execution of a valid will. These requirements will vary between States and Territories.
The will sets the terms of the trust. The will should identify a Trustee (or Trustees), beneficiaries, an appointor (if necessary) and the assets that pass into the trust. The will can provide full discretion for the Trustee as to who should receive the capital and income of the trust. Alternatively the trust may be established so that no discretion is given to the Trustee but the entitlements are fixed.
In many cases the Trustee established under the Will is the same person as the Executor of the Estate but this need not necessarily be the case. Testamentary trusts can be used for a variety of purposes but some of the more common purposes include:
- Tax effectiveness for both income and capital;
- Protection of assets if the beneficiary is involved in a family law property dispute;
- Care for children that cannot care for themselves;
- Protection of assets where beneficiaries suffer various addictions;
- Protection of spendthrift beneficiaries from themselves;
- To protect an inheritance from a beneficiary who might be a spendthrift;
- Protection from business creditors; and
- Protection from legal actions brought against beneficiaries.
Any property that can be passed through an Estate can be placed in a testamentary trust.
Inability to delegate testamentary capacity
One of the technical aspects in drafting a will that includes a testamentary trust is the need to ensure that the Testator/Testatrix does not delegate or leave the selection of the beneficiaries to another person. This means that the Testator must nominate specific beneficiaries or a class of beneficiaries whom the trustee can choose between to benefit under the will.
Testamentary Trust Strategies
Minor beneficiaries
Where any child under the age of 18 is a beneficiary of a testamentary trust the income that they are ‘presently entitled’ to will be excepted trust income.
This means that the income will not be caught under the penal rates of tax imposed on minors, rather a resident minor beneficiary will receive the benefits of a resident adult’s tax-free threshold and the relevant marginal rates of tax on income to which they are presently entitled and which is in excess of that amount.
The tax benefits that arise under sec 102AG are not reliant on the income being spent for the benefit of the minor beneficiary of the trust. The relevant rules of present entitlement apply and the income does not actually have to be given to them. The Trustee can establish a loan account in favour of the minor beneficiary and spend the money on behalf of the children for their education, maintenance and advancement.
The parents can take out a separate credit card to cover the expenses and have the account paid by the testamentary trust. This provides a clear audit trail.
Protection Through a Testamentary Trust
Inheritances, like other assets, can form part of the matrimonial property that is available to the Family Court to divide in the event of a marriage breakdown and property dispute.
Assets placed in a properly structured testamentary trust may be capable of being kept outside the concept of ‘marital property’ and not included amongst those assets that are vulnerable to orders of the Family Court.
It is important to point out that the Family Court may, however, consider the presence of the trust in calculating what they consider to be an equitable distribution of the assets.
Where a beneficiary is having trouble with creditors or facing bankruptcy, then any assets that they receive under a Will could pass directly to their creditors. In these circumstances a testamentary trust can help keep the assets out of the reach of present and future creditors.
These assets and the income produced by them will still be available for family members and, in particular, the children of the insolvent person.