Much of the public discussion surrounding the Federal Government’s proposed tax reforms has focused on negative gearing, capital gains tax, and discretionary trusts.
However, one of the more important conversations occurring amongst lawyers, accountants and financial advisers is about testamentary trusts and the continuing importance of proper estate planning.
While the Government has indicated that certain testamentary trust arrangements may continue receiving concessional treatment under the proposed reforms, the real value of a testamentary trust has never simply been taxation.
For most families, testamentary trusts are fundamentally about protecting vulnerable beneficiaries and preserving family wealth over the long term.
What Is a Testamentary Trust?
A testamentary trust is a trust created under a Will that comes into existence after a person dies.
Instead of assets passing directly to beneficiaries personally, assets are held and managed by a trustee for the benefit of the beneficiaries in accordance with the terms of the Will.
This structure allows far greater flexibility and protection than a simple “gift outright” arrangement.
Importantly, testamentary trusts are not only used by wealthy families.
They are commonly used by:
- business owners;
- professionals;
- blended families;
- farming families;
- parents with younger children; and
- families concerned about protecting inheritances over time.
Protecting Beneficiaries From Relationship Breakdown
One of the most common concerns parents raise during estate planning appointments is protecting their children’s inheritance if a relationship breaks down.
If assets are inherited personally, they may become exposed in future family law proceedings.
While no structure provides absolute protection, testamentary trusts can significantly improve the protection of inherited assets by:
- separating legal ownership and beneficial enjoyment;
- restricting control over distributions;
- preventing automatic mingling of inherited assets; and
- allowing trustees greater discretion over how assets are managed.
For many parents, this protection is one of the primary reasons they choose testamentary trust Wills.
Protection Against Bankruptcy and Creditors
A direct inheritance may also become vulnerable if a beneficiary experiences:
- business failure;
- personal insolvency;
- creditor claims; or
- litigation.
By contrast, assets held within a properly structured testamentary trust may provide substantially greater protection against external claims.
For business owners, professionals and families with intergenerational wealth, this issue has become increasingly important.
Many parents are less concerned about minimising tax than ensuring family assets are not lost due to unforeseen financial circumstances affecting a child or grandchild.
Protecting Vulnerable Beneficiaries
Testamentary trusts are also commonly used where beneficiaries may be vulnerable due to:
- disability;
- addiction;
- gambling problems;
- financial immaturity;
- mental health concerns; or
- susceptibility to undue influence.
A well-drafted testamentary trust can allow a trusted person to:
- manage investments;
- control distributions;
- preserve capital; and
- ensure funds are used appropriately for the beneficiary’s welfare.
Without these structures, inheritances can sometimes be dissipated very quickly.
The Current Tax Treatment of Testamentary Trusts
Under the current taxation rules, income received by minors from most discretionary trusts is generally taxed at punitive penalty rates.
These rules were introduced to discourage income splitting arrangements involving children.
However, an important exception exists for certain income derived from deceased estates and testamentary trusts. This is commonly referred to as “excepted trust income”.
Broadly, where income is derived from assets originating from a deceased estate and held within a properly structured testamentary trust, minor beneficiaries may be taxed at ordinary adult marginal tax rates rather than punitive minor tax rates.
This treatment can create significant practical benefits for children who have lost parents and are dependent on trust income for their ongoing support and welfare.
Example – Children Losing Both Parents
For example, assume both parents die in a motor vehicle accident leaving a $2 million investment portfolio and the family home to a testamentary trust for the benefit of their two children, aged 8 and 11.
The investment portfolio generates $60,000 of income annually.
Under the current excepted trust income rules, the trustee may distribute $30,000 to each child and, because the income is derived from assets originating from the deceased estates, the children may be taxed at ordinary adult marginal tax rates rather than punitive minor tax rates.
Under the current tax rates, each child would generally pay approximately:
- nil tax on the first $18,200; and
- 16% on income between $18,201 and $45,000.
On a $30,000 distribution, this would currently result in tax of approximately $1,888 per child.
Combined, the two children would therefore pay approximately $3,776 in total tax on the $60,000 income.
By contrast, if the proposed minimum 30% tax regime were extended to apply to testamentary trust distributions of this nature, the taxation outcome could change dramatically.
Under a flat 30% minimum tax:
- each child’s $30,000 distribution could attract tax of approximately $9,000; and
- the total tax payable across the two children could increase to approximately $18,000.
This would reduce the net income available to support the children by more than $14,000 per year.
Importantly, this directly affects funds available for:
- school fees;
- housing costs;
- medical expenses;
- extracurricular activities; and
- long-term financial support following the death of both parents.
The example demonstrates why many advisers are concerned about preserving the existing excepted trust income rules for testamentary trusts involving vulnerable children.
Protecting Children and Future Generations
Many clients are also concerned about preserving wealth for future generations.
If assets pass directly to children personally, there is often little control over:
- how assets are used;
- whether they remain within the family bloodline; or
- what ultimately happens after the child’s death.
Testamentary trusts allow families to build long-term protective structures that can continue benefiting children, grandchildren and later generations.
For some families, this is about preserving a family business or investment portfolio. For others, it is simply about ensuring hard-earned assets remain available to support future generations.
The Tax Reforms Highlight the Importance of Proper Structures
The proposed tax reforms have caused many families to reconsider how assets should be owned and transferred between generations.
While taxation remains relevant, the reforms also reinforce a broader point:
Estate planning should never be driven solely by tax outcomes.
Good estate planning is about:
- protecting vulnerable people;
- reducing family conflict;
- preserving control;
- safeguarding assets; and
- ensuring wealth is transferred responsibly.
In many cases, a properly structured testamentary trust may achieve these objectives far more effectively than a simple Will leaving assets directly to beneficiaries.
Existing Wills May No Longer Be Adequate
Many existing Wills were prepared years ago and may not adequately address:
- blended family risks;
- modern asset protection concerns;
- business succession issues;
- vulnerable beneficiaries; or
- changing taxation laws.
Some older Wills do not contain testamentary trust provisions at all.
For families with businesses, investment properties, or significant accumulated wealth, this can create substantial long-term risk.
Estate Planning Is Increasingly About Control and Protection
Modern estate planning is no longer simply about deciding who receives assets after death.
Increasingly, clients are seeking advice about:
- who controls assets;
- how assets are protected;
- how beneficiaries are supported over time; and
- how family wealth can be preserved responsibly.
Testamentary trusts remain one of the most effective legal tools available to achieve these objectives.
How Crest Lawyers Can Assist
Crest Lawyers advises clients on:
- testamentary trust Wills;
- asset protection planning;
- blended family estate planning;
- succession planning;
- business and family wealth structures; and
- protection strategies for vulnerable beneficiaries.
If you would like your estate planning arrangements reviewed, please contact our office.