WHAT IS A TESTAMENTARY TRUST?
A Testamentary Trust is simply a trust established by a person’s Will. As opposed to more “simple” Wills, where beneficiaries receive the benefit of any gift personally, with a Testamentary Trust, the beneficiaries receive the benefit of the gift but rather than having it legally owned by them personally, a trustee holds the relevant asset in trust for them.
Wills with Testamentary Trusts are recommended by many lawyers, accountants and financial advisers for various reasons, including asset protection and taxation advantages.
ASSET PROTECTION
Because of the legal ownership being different to the beneficial interest, Testamentary Trusts can offer beneficiaries significant and important advantages such as asset protection. As the trustee of the Testamentary Trust owns the asset (not the primary beneficiary personally), creditors and trustees in bankruptcy of the relevant beneficiary cannot gain access to the asset.
Often, beneficiaries are in business for themselves and have implemented asset protection measures so as to keep their assets safe from claims by third parties. The last thing that beneficiary may want is to receive an inheritance in their personal name, effectively undoing all of their efforts to safeguard their assets!
There can be significant tax advantages in taking an inheritance through a testamentary trust, in addition to asset protection.
Testamentary Trusts can be drafted so as to have the beneficiary effectively control the trust and for that control to be relinquished on the occurrence of certain events, such as bankruptcy or divorce/marital separation, with a nominated person to act in the role of trustee whilst that incapacity remains.
TAXATION BENEFITS – INCOME SPLITTING
Rather than taking a gift in a personal capacity as would usually be the case with a more “basic” Will, with a Will that incorporates Testamentary Trusts, beneficiaries have the ability to split income earned among other people in their family such as spouses, children, grandchildren or any other company or trust in which they have an interest.
Where an estate has income producing assets such as an investment property, under a more “simple” will, the person who received that gift would have the income earned from that asset added on top of the income they already receive from their employment or investments. This could mean that they go into the next marginal tax bracket and pay significantly more tax.
A Testamentary Trust allows the income earned to be split amongst the various family members, many of whom are likely to either not be working (so the tax free thresholds become available) or earn lower incomes (and are therefore in lower taxation brackets).
Children that receive income from a Testamentary Trust are taxed at marginal rates as if they are adults (as opposed to the usual discretionary / family trusts, where they are taxed at unearned income penalty tax rates) so for a family with a non-working spouse and several children, significant income can be received whilst very little or no tax may be payable on the testamentary trust income.
*The above regarding potential tax minimisation may no longer be effective as of 12 May 2026 with the taxation changes proposed by the Federal Labor Government.
FURTHER INFORMATION
Craig Pryor is principal solicitor at McKillop Legal. For further information in relation to estate planning, business succession or any other commercial law matter, contact Craig Pryor on (02) 9521 2455 or email craig@mckilloplegal.com.au.
