Welcome to my weekly Insights blog. Once a week, we cover topics such as wealth creation, super, estate planning and tax. This is Part 5 of our 10-part series on how wealthy Australian families build, protect and pass on their wealth.
Most Wills leave everything to the children outright. It’s simple, but it means the inheritance lands in their personal names, exposed to their creditors, a future divorce, and their own high marginal tax rate.
Wealthy families often do it differently. Their Wills create testamentary trusts, so each child’s inheritance is held in a trust that protects it and can save tax for years to come.
Key takeaways
- A testamentary trust is a trust set up by your Will. It only comes into existence after you die.
- It can protect an inheritance from a beneficiary’s creditors, bankruptcy or relationship breakdown.
- Income distributed to children and grandchildren under 18 is generally taxed at normal adult rates, including the tax-free threshold, instead of penalty rates.
- Since 1 July 2019, that concession only applies to income from assets that came from the deceased estate.
- Testamentary trusts cost more to set up in your Will and need an annual tax return, so they suit larger estates or families with specific risks.
What is a testamentary trust?
A testamentary trust is a trust written into your Will. Instead of leaving your daughter $1 million outright, for example, your Will leaves it to a trust where she is the main beneficiary, and usually the trustee or one of the controllers.
She can still use the money, invest it, and benefit from it. But because the trust holds the assets, it’s not simply her personal property. And each year, the trustee can decide how to distribute income among her family.
Benefit 1: asset protection
Assets held in a well-drafted discretionary testamentary trust are generally harder for a beneficiary’s creditors or trustee in bankruptcy to reach. That matters for children who run businesses, work in high-risk professions, or may face financial trouble.
It can also help in a relationship breakdown, as we covered in Part 2. The protection is stronger when control is shared, for example with a sibling or independent co-trustee, rather than held by the child alone.
Benefit 2: tax savings for grandchildren
Normally, unearned income paid to children under 18, such as trust distributions, is taxed at penalty rates designed to stop income splitting. Income from a testamentary trust is an exception. It’s taxed at normal adult rates, so each child can receive income up to the tax-free threshold of $18,200 without paying tax.
For a family with three young children, that could mean more than $50,000 a year of investment income taxed at little or nothing, instead of at a parent’s top marginal rate. Over 10 or 15 years, the savings can be substantial, and can fund school fees or a first home deposit.
Since 1 July 2019, this concession only applies to income from assets that came from the deceased estate, or assets bought with them. Adding your own money to a testamentary trust won’t get the same treatment.
Types of testamentary trust
| Type | Best for | Key feature |
|---|---|---|
| Discretionary testamentary trust | Most families | The trustee decides distributions each year for flexibility and tax planning |
| Optional (“elective”) trust | Families who want flexibility | Each child chooses whether to take the inheritance outright or in a trust |
| Protective trust | Vulnerable beneficiaries, such as those with addiction, gambling or spending problems | An independent trustee controls the money and pays it out for the beneficiary’s needs |
| Special disability trust | A family member with a severe disability | Can help preserve Centrelink benefits, but has strict rules |
Is it right for your family?
A testamentary trust is usually worth considering if:
- Your estate, including super paid to your estate and life insurance, is substantial
- You have young grandchildren, or children likely to have them
- A child runs a business, is in a high-risk profession, or has an unstable relationship
- A beneficiary needs protecting from themselves or others
The trade-offs are a more complex Will, which costs more to prepare, and an annual trust tax return once the trust is running. For smaller estates, the cost may outweigh the benefit.
Frequently asked questions
What is the difference between a family trust and a testamentary trust?
A family trust is set up during your lifetime with a trust deed. A testamentary trust is set up by your Will and only starts after you die. Income from a testamentary trust paid to minors is generally taxed at adult rates, which isn’t the case for a family trust.
Can super go into a testamentary trust?
Yes, if your super death benefit is paid to your estate, for example through a binding nomination to your legal personal representative. It can then flow into the testamentary trusts set up by your Will.
Can I add a testamentary trust to my existing Will?
Usually you’d make a new Will rather than amend the old one, because testamentary trust clauses are detailed. Your estate lawyer can advise on the best approach.
A Will that keeps working after you’re gone
A simple Will hands over your wealth in one go. A Will with testamentary trusts keeps protecting your family and saving tax for decades. It’s one of the clearest examples of how wealthy families plan differently.
At TaxAssist Accountants Dee Why, we model the tax benefits of testamentary trusts for Northern Beaches families and work alongside your estate lawyer to get the structure right. Call us on (02) 9045 1511 or email [email protected] to find out if one suits your family.
This article contains general information only and does not take into account your personal circumstances. It is not legal or financial product advice. Wills and testamentary trusts should be prepared by a qualified lawyer.
