Extra accounting fees v tax-free inheritance for your kids and grandkids — will the setup and ongoing management costs of a testamentary trust pay off? Photo: oneinchpunchphotos.
It’s framed as a brilliant way to save on tax and safeguard your family’s wealth, but is a testamentary trust worthwhile or just an added expense and hassle?
According to estate law experts, the reality comes down to what you actually own.
“Some people think testamentary trusts are only for the super wealthy, but most estates these days are worth protecting,” BDN Lawyers partner Lorraine White says.
“Most people have a home, often superannuation or even a residential aged care bond. If you’ve got those kinds of assets, you’ve got an estate.”
A testamentary trust is a structure created within a will to protect your beneficiaries’ inheritance from legal risks and potentially reduce the tax they pay on the income it generates.
Unlike standard discretionary trusts, it needs to be established in your lifetime but only activates after you die.
Within a family, it allows you to bequeath your estate to your children while protecting the legal implications of family law disentanglement, such as divorce.
For business owners, it prevents a bankruptcy trustee from seizing family money to satisfy commercial debts.
“Essentially, it puts a big quarantine around the gift that you give to the beneficiary because it’s held in a trust,” Lorraine says.
However, that quarantine only holds if the trust is drafted properly. If a beneficiary serves as the trust’s sole trustee, a family court or bankruptcy trustee can argue that the money is effectively theirs.
“That’s why, when I’m drafting these documents, I include a provision that automatically strips the beneficiary of control if a relationship breaks down,” Lorraine says.
“They have to transfer the trusteeship to someone else, like a brother or a sister. This control issue is quite critical to get that level of protection in both family law and bankruptcy proceedings.”
Lorraine recalls a case where a grandparent left $3 million to a grandchild who had a $1 million mortgage. Rather than paying off the debt directly, the grandchild and her husband borrowed $1 million from the trust.
“It enabled the newly married couple to pay their interest payable on their loan to the trust rather than their bank, while keeping the loan recorded as a trust asset, ensuring the money remained protected from the marital asset pool should the relationship ever break down,” Lorraine says.
BDN Lawyers partner Lorraine White says testamentary trusts are not reserved for the super wealthy. Photo: BDN.
While asset protection is often the primary driver, the secondary advantage is tax efficiency – particularly where children are involved.
Recent budget discussions around taxing all trusts at 30 per cent briefly sparked concern, but the government ultimately backtracked, confirming testamentary trusts will maintain their existing tax benefits.
While normal trusts hit under-18s with top tax rates on income after just $416, a testamentary trust allows children to receive income and use the full adult marginal tax rates, including the tax-free threshold.
Where that really shines is how a testamentary trust can help a surviving parent. If a spouse dies, leaving insurance or super to their estate, the surviving spouse can distribute that income directly to minor children to pay for school and living expenses.
“If you have three minor children, that can be the difference between receiving $45,732 tax-free to spend on your kids versus adding $45,732 to your taxable income and having a big chunk of that go straight to tax,” Lorraine says.
Despite these benefits, a testamentary trust is not a set-and-forget tool.
Every dollar earned must be distributed in the same financial year (meaning, no hoarding cash), and requires an annual tax return and ongoing accounting fees.
“It’s a balancing act as to whether you’re happy to pay those additional costs and impose managing those on your children,” Lorraine says.
To ensure adult children aren’t burdened unnecessarily, Lorraine drafts flexible provisions that give beneficiaries the choice to accept the inheritance outright or activate the trust structure.
“That way you don’t force a complex structure on kids who don’t need it,” she says.
Ultimately, the only alternative to a testamentary trust is a standard will, which is cheaper and simpler but offers no asset protection or tax savings.
To decide if the extra costs are worth it, consider whether the value of your estate is substantial, whether you have minor children or grandchildren to pass income to tax-efficiently and whether any beneficiaries are at risk of divorce, bankruptcy, or financial exploitation.
“If none of those applies, a standard, simple will is usually cheaper and easier,” Lorraine says.
“If we think a testamentary trust is not necessary for whatever reason, we will tell you.”
For more information, contact BDN Lawyers.
