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A Testamentary Trust is a very effective estate planning tool to provide for children and grandchildren, and in 2015, is becoming more and more popular.

So what is a Testamentary Trust?

It is used to describe what is usually a Discretionary Family Trust established under a will.

Why is it so popular?

This arises from the considerable benefits that can flow from their establishment. These benefits arise because although assets of the trust may be controlled by the intended beneficiary, they do not form part of that beneficiary’s estate. A major benefit of a testamentary trust is its ability to protect assets and to reduce tax paid by the beneficiaries from income earned from their inheritance.

This provides a greater level of control over the distribution of assets to beneficiaries.

Below are five smart reasons why you should consider a testamentary trust:

1. CGT benefits

Assets owned by the deceased that would have been subject to Capital Gains Tax (CGT) had the deceased sold them before their death, can pass through their estate to the testamentary trust with no CGT event occurring.

If the asset was a pre-CGT asset, the trust will have a cost base of the market value of the asset at the date of death. If the asset is a post CGT asset, then the trust will inherit the deceased’s cost base. This is particularly important where the assets have significant unrealised capital gains. This also provides a good opportunity to “reset” the ownership of assets subject to CGT.

If for example, mum and dad own the shares in a company that is the corporate beneficiary of their family trust. The shares have a nominal cost base but because of trust distributions made over a number of years (and often not paid in cash) the company can become very valuable. All of that increased value is potentially subject to CGT if mum or dad moved the ownership of these shares during their lifetime. However, after their death the shares can be moved to a testamentary trust and dividends from the company can be distributed by the trust to a range of beneficiaries.
In addition, trust assets can be transferred to beneficiaries without incurring CGT. This only applies to assets of the trust that were owned by the deceased when they died.

2. Income Tax Assessment Act advantages

Income can be distributed from a testamentary trust to infant beneficiaries and taxed in those children’s hands at adult marginal tax rates. This is a consequence of the testamentary trust being capitalised from the deceased’s estate. The testamentary trust can, over time, sell and replace the original assets that came from the estate and the distributions to the infant beneficiaries continue to be taxed at adult rates.

With the tax free threshold of $18,200 in 2013/14, testamentary trusts are even better vehicles for clients because children under the age of 18 years who receive income from a testamentary trust are taxed on that income as an adult and therefore enjoy the nominal tax free threshold of $18,200 (in 2013/14 or $20,542 if the low income tax offset applies) and marginal tax rates which apply to adults.

Without this special provision (and excluding the Medicare levy), trust distributions to minors may only access a tax free threshold of $416 and thereafter the effective tax rate applied to the minor’s income is 66% of income up to $1,307 and 45% after $1,308 on the entire amount of income.

3. Flexibility to the Trustee

The trustee also has the freedom to buy and sell the underlying assets of the trust (and thereby grow the value of the trust) without losing or endangering any tax advantage.
It is helpful if you provide the Trustee with some guidelines about the administration of the trust but we suggest that they are carefully framed in order to avoid any confusion or legal or accounting complications.

4. Protection of the assets

The testamentary trust provides a level of protection to the assets held in the trust. It provides protection against Creditors of the beneficiaries who may want to recover from the trust assets an amount owing to them by a beneficiary and as well in the Family Law Court in the case of divorce of a trust beneficiary.

In the case of bankruptcy often a wife will guarantee her husband’s business venture and vice versa. To some extent we can all be at risk whether in high risk occupations or not. However, if the bankrupt’s inheritance has been provided through a testamentary trust it will be protected from creditors.

In the Family Court, an inheritance held within a testamentary trust is likely to invoke the attention of a Family Court in the case of a marriage break-up. A trust set up for this purpose needs special attention and will have to be framed in a very strict way in regard to the distribution of funds.

5. Protecting “at risk” beneficiaries

It is not uncommon for people suffering a variety of disabilities to be unable to properly manage their financial affairs. At the same time, families may wish to ensure that an adequate fund is set up to meet their beneficiaries’ reasonable needs but so as not to affect any pension rights they may have.

These people can be described as being “at risk”, a description that for example may include people who are drug or gambling addicted, disabled mentally or physically or simply spendthrifts who are not capable of looking after any wealth that could be left to them. For these people a testamentary trust can be managed by the trustee, (who should be) a responsible and capable person (or people) who take action for the benefit of the “at risk” person.
There are now Special Disability trusts that can be used in circumstances where there is a child beneficiary in receipt of a Disability pension and the inheritance may effect entitlement to their benefits and entitlements.

Summary

In 2015 it is becoming more common to steer away from the traditional husband and wife will, which provides for a husband and wife giving to each other and then to the children, being replaced by a testamentary trust controlled by the surviving spouse and under which the spouse and children are potential beneficiaries. If the funds in the trust justify it, wills along these lines can provide that on the death of the spouse, sub-trusts come into existence for the benefit of each child and that child’s family – and controlled by the child concerned.

Testamentary trusts are a very powerful and useful estate planning tool. The flexibility of a testamentary trust, especially if combined with a memorandum of wishes as to how the trust should be administered, can be both an appropriate arrangement as well as being a highly advantageous tax mechanism.

To find out more about how testamentary trusts can benefit you, call us on (02) 9502 2922 or email advice@falzonlegal.com.au today.