Plain English Guide to Testamentary Discretionary Trusts

There are many structural benefits associated with Testamentary Discretionary Trusts including asset protection and taxation. This Plain English Guide answers some of the more commonly asked questions about creating a Testamentary Discretionary Trust, but remember that your lawyer is available to answer any other questions or provide advice when you need it.

When making a Will most parents want to benefit their children following the death of the survivor of the parents. A typical Will would leave the estate to the children equally and then contain some further provision as to what is to happen if a child happens to die before the parents.

There are three inevitable consequences of this type of a Will.

  • If a beneficiary inherits and then subsequently encounters financial difficulty or is declared bankrupt the whole of his or her inheritance would be available for the payment of debts.
  • If a beneficiary subsequently encounters marriage or relationship difficulties the whole the inheritance, being his or her absolute property, would be available for the Federal Circuit and Family Court of Australia ruling as to the couple’s property settlement.
  • When the beneficiary invests his or her inheritance the income on that investment would normally be taxed at the beneficiary’s marginal tax rate. If the beneficiary is earning other income the taxation rate would frequently be up to 45%.

In order to avoid these problems and also to provide numerous other advantages many Wills are now prepared using Testamentary Discretionary Trusts. Instead of benefiting each of your children directly your Will creates a separate Trust (or fund) for each of them.

Let’s say that you have three children – A, B and C – and they are all of age and look after their own affairs. Three Trusts or separate funds would be created. A would be the Trustee (or controller) of his/her Trust and each of the other children would also control their Trust.

The potential beneficiaries of A’s Trust would typically be A, A’s spouse, A’s children, A’s grandchildren and their spouses.

The Will would provide that the capital of A’s Trust is to be held on trust for such one or more of those beneficiaries as the Trustee (A) decides, and that the Trustee can make that decision at any time within 80 years after the Willmaker’s death. Accordingly A has access to the capital at any time if he/she wants it to become his/her absolute property.

While the capital remains in the Trust, the Trustee normally would invest it or apply it for the benefit one or more of the beneficiaries. The Will would provide that the Trustee has the absolute discretion either to accumulate the income from any investment within the Trust or to pay that income to any one or more of the potential beneficiaries, again as the Trustee decides in his or her own absolute discretion.

As a consequence of these arrangements:-

1. Asset Protection

The Trust assets are not the property of A or any of the other beneficiaries during the lifetime of the Trust. They are therefore not generally available to the Trustee in Bankruptcy for payment of creditors.

2. Family Law

The assets of the Trust are unlikely to be regarded as property of any of the beneficiaries for family law purposes. However, it must be understood that the Federal Circuit and Family Court does have power to consider not only the assets of the parties to the marriage but also their financial resources and it may well be that the Court would regard Trust assets as a family resource in making its orders.

Nevertheless the Court would be unlikely to disregard the rights of other potential beneficiaries and the result could always be expected to be better than if the Trust assets belonged to A or one of the other beneficiaries absolutely.

If family law or bankruptcy issues were of real concern it is possible to introduce a variety of measures which would make it less likely that the Courts could treat the assets as property or as a resource but those measures would invariably have their own consequences which would need to be carefully considered.

3. Taxation

Each of the children would have the ability to share the income from the investment of the Trust capital with the other beneficiaries of his or her Trust, thus minimising the income tax on that income. In particular (because the Trust arises under the Will of a deceased person) infant beneficiaries would be treated as separate taxpayers in relation to the income earned from that Trust. Each of those infant beneficiaries would be entitled to the normal tax free threshold and would thereafter be assessable at the lowest income tax rate of 15c in the dollar. This benefit is only available in respect of Trusts arising from deceased estates.

The Trusts do not come into effect until after death so there are no running costs until that time. Any additional complication or cost after the date of your death would invariably be more than compensated for by the benefits.

Testamentary Discretionary Trusts are extremely flexible and can be designed to operate effectively in most situations. By gaining a better understanding of your individual circumstances your Coleman Greig lawyer can assist you in tailoring a solution that best meets your requirements.

For more information on your role as the Executor of a Will, please contact our Wills & Estates Planning team.


Disclaimer: The information provided in the document is a general summary and is not intended to be nor should it be relied upon as a substitute for legal or other professional advice.


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