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Testamentary trusts

Commonly asked questions about testamentary trusts:

A testamentary trust is a trust established by a will. Testamentary trusts offer valuable taxation and asset protection benefits to the beneficiaries of a will.

Unlike a typical will, where each beneficiary is left their inheritance outright, in a will that contains testamentary trusts, each beneficiary is left their inheritance as trustee of a trust with wide discretionary powers. As trustee, beneficiaries have complete authority over who benefits from the trust, and to what extent. They are able to retain complete control of their inheritance.

A testamentary trust can continue for up to 80 years from a person’s death, so it can benefit several generations of family members. There is no limit to how many testamentary trusts may be created under a will. You may choose to create one for each beneficiary in your will.

Bear in mind that there is no “one size fits all” testamentary trust. It is important that any will that incorporates testamentary trusts is prepared by a lawyer who is experienced and skilled in tailoring a document of this nature to your specific circumstances.

The advantages of a testamentary trust to the beneficiary of a will are many.

  • Income and capital gains tax savings – a beneficiary may be able to reduce personal income tax by splitting income from the investment of the inheritance between a range of family members, including children, at low tax rates. And a beneficiary may also be able to minimise capital gains tax which can arise from the sale of a person’s assets after their death.Consider this example. John receives a $500,000 inheritance. John invests his inheritance and earns $50,000 interest annually. As John’s personal income attracts the highest marginal tax rate, John pays additional income tax of $24,000 out of the interest earned by his invested inheritance. If John had received his inheritance through a testamentary trust, he would have been able to split the income equally between his non-working wife and children, who could have each paid no tax at all, representing a tax saving of $24,000 to John.
  • The beneficiary’s inheritance is protected from creditors – assets that pass to a testamentary trust from an estate are owned by the trust. The assets are not owned personally by the beneficiary and they do not form part of the beneficiary’s personal estate, so a creditor cannot take the assets held in the trust. Consider these two examples.Jack owned his own business, which was placed in liquidation during an economic downturn. As a result, Jack was made bankrupt. A year earlier, Jack received an inheritance of $500,000.00 from his mother. As Jack received his inheritance in his own name, it was able to be taken and used to pay creditors of Jack’s business. If Jack’s mother had included a testamentary trust in her will, Jack’s inheritance may not have been available to creditors of his business.

    Sally owned and ran a successful hairdressing saloon. She had deliberately ensured that most of her assets were in her husband’s name, so that if her business went bad, their home and savings would be protected. When Sally’s mother died, she inherited her mother’s house – unfortunately in her name. Though the business was doing well, its future success was not guaranteed. To protect her inheritance from the risk of a future possible failure of her business, she transferred it to a trust and paid $23,000.00 in stamp duty. This expense could have been avoided if Sally’s mother had included a testamentary trust in her will.

  • The beneficiary’s inheritance is protected from family law claims – a testamentary trust may provide some protection for a beneficiary who is experiencing relationship difficulties. By providing for a beneficiary’s entitlement to be held in a testamentary trust, the beneficiary can isolate their inheritance from their personal assets. This may protect their inheritance from family law property proceedings.Consider this example. When Mary died, she left her only son Jack an inheritance of $500,000.00. Jack had been married to Jill for 10 years at the time, but they separated shortly after. Jack and Jill’s matrimonial property amounted to $300,000.00 after the mortgage was taken into account. In determining the property settlement, the court took into account Jack’s inheritance, but because of the terms of the testamentary trust that held those funds, the court did not include those funds in what was available for distribution to Jill. Thus the only property available to be distributed was $300,000.00, and although Jill did get more than half of that sum, it was less than she might have received if Jack’s inheritance had been held by him in his own name, rather than in a testamentary trust.
  • Vulnerable beneficiaries are protected – in appropriate circumstances, a special protected testamentary trust can be created to protect the interests of a beneficiary who is vulnerable, for example, because of a physical or mental disability, an addiction, problems with creditors or a relationship breakdown. It may be set up in such a way as to protect vulnerable beneficiaries from losing the wealth and assets they inherit, for example, through gambling or drug or alcohol addictions.

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