A trust is a relationship that arises at law under which an entity (trustee) holds property for the benefit of another (beneficiary). A common example is where a person (the “settlor”) transfers the legal and equitable title of certain property to another person or entity to hold that property on the behalf of, and for the benefit of, one or more third parties.
The term “testamentary trust” refers to a trust created under a Will.
In practice, a person will include a provision in their Will appointing an individual (or individuals) to be their testamentary trustee(s). The testamentary trustee(s) is obligated to hold certain property for the benefit of the beneficiaries of the testator’s Will upon the person’s death.
If the testamentary trust is in the form of a discretionary trust, the trustee may have the power to distribute the income or capital or both of the trust amongst the beneficiaries in such proportions and at such times as the trustee thinks appropriate. The trust might be timed to end once all beneficiaries are of full age and capacity, or at some other specified time but it can exist in perpetuity.
The testamentary trustee(s) has the same fiduciary obligations and is required to maintain the same strict standards as other trustees.
A testamentary trust can be structured to give beneficiaries up to three significant benefits.
A testamentary trust in the form of a discretionary trust can be advantageous when it comes to income splitting. That is, if one beneficiary has a high income and another a lower one, the trustee may decide to apportion more income from the trust to the latter. A consequence of this may be that less income tax is paid on the trust income than if it accrued to a single beneficiary.
Of particular significance in this context is that income flowing from a testamentary trust to a minor beneficiary can be taxed in the same way as that flowing to an adult, meaning the tax free threshold and progressive rates apply, unlike the case with income flowing to a minor from a discretionary trust created by a living person. For this to be the case the income needs to qualify as “excepted trust income” defined in Section 102AG(2) in the Income Tax Assessment Act (1936).
A ‘normal’ Will would leave assets directly to beneficiaries (for example, if a spouse dies, then to the surviving spouse). If that surviving spouse later becomes bankrupt or remarries and the new marriage later breaks down, those assets, if held by the surviving spouse personally, can be attacked by creditors or the ex-partner.
If held under a testamentary trust, assets are not held by the spouse personally. Instead, the assets can be held in the testamentary trust for the potential benefit of the surviving spouse and others (e.g. children). This way, if there is a risk of claims by a creditor or an ex-partner, the trustees of the testamentary trust can:
When drafting a Will, it can be difficult to know what each beneficiary’s personal and business circumstances will be at the time of the testator’s death. Rather than receiving an inheritance in their personal names, a beneficiary may prefer to have assets to be inherited held by another entity, such as a company or a trust.
Because a ‘normal’ Will would leave assets directly to the beneficiary, the beneficiary may have to pay stamp duty or capital gains tax if an inherited asset is received by the beneficiary and then transferred to the preferred holding entity.
By using a testamentary trust those inherited assets may be able (if the beneficiary chooses) to be transferred directly to the preferred holding entity without paying stamp duty or (in some circumstances) capital gains tax.
This communication provides general information which is current as at the time of production. The information contained in this communication does not constitute advice and should not be relied upon as such. Professional advice should be sought prior to any action being taken in reliance on any of the information. Should you wish to discuss any matter raised in this report, or what it means for you, your business or your clients' businesses, please feel free to contact us.