Testamentary Trust Wills create a discretionary trust upon the death of a testator which gives the trustee of that trust the power to distribute the trust’s income, at their discretion, to the beneficiaries of the trust.
There are several circumstances when a testamentary trust should be made. These circumstances include:
- When the size of the estate is likely to be over $500,000.00.
- When the estate consists of investments which it may not be beneficial to dispose of.
- If there are concerns that a beneficiary will waste a significant portion of the estate’s assets if they were to receive their inheritance all at once.
- If a potential beneficiary has a drug, alcohol or gambling problem or other addiction.
- If the testator wishes to pass on tax benefits to the beneficiaries.
- If a beneficiary suffers from a disability, especially a mental disability.
One of the most important benefits that a testamentary trust creates are the tax benefits available to the beneficiaries.
In order to illustrate the tax benefits that the trust offers, let’s assume that Tom receives a $2,000,000 inheritance from the passing of his mother. Tom is a high income earner in the top tax bracket and has four children. Tom invests the $2,000,000 in a bank account receiving 6% per annum creating $120,000 of income in one financial year. On that income amount he would pay 45% tax (being the current tax rate) plus the Medicare levy with a total of $55,800 of the income being paid as tax. This would leave $64,200 left from the interest earned.
Now for the testamentary trust. Assuming Tom earned the same $120,000 in interest under the trust, he would be able to distribute the income earned between his four children so that the income is not included under his tax return. Provided that the children are not working, Tom can make use of the tax free threshold of each child (currently at $18,200 as of 30 June 2015). This means each child would report their income tax for the year as $30,000 with each child only paying $1,192 tax each, totalling $4,768. This would therefore leave $115,232 left from the interest earned, a difference of $51,032 more than if a testamentary trust didn’t exist.
The other benefits of a testamentary trust include the flexibility for beneficiaries to use assets, such as beach houses or cars, without the necessity to sell or dispose of them. It also gives the beneficiaries the ability to make a choice as to whether to establish the trust or take their inheritance outright.
The trust can also delay or remove the time at which the beneficiaries can take control of the trust if it is believed that the beneficiary is not old enough or is not capable or responsible enough to manage their finances.
The trust can also provide protection against creditors of the beneficiaries who may be able to recover assets if they weren’t protected within the trust.