A testamentary discretionary trust is a type of trust written into a Will but which is only established after the will maker passes away. With recent Australian research suggesting a potential intergenerational wealth transfer in the amount of $3.5 trillion dollars set to take place in the next 20 years, testamentary discretionary trusts are a key strategic tool for comprehensive estate planning.
There are different types of testamentary trusts to consider, depending on your unique familial circumstances and financial situation. In this article, we focus on testamentary discretionary trusts and how they help protect you and your family’s assets during challenging life events such as divorce and death.
When you engage an experienced estate planning lawyer, they’ll explain the details of how a testamentary discretionary trust can work for you, but generally speaking they provide 3 key benefits:
- Asset protection
- Flexibility for beneficiaries
- Tax minimisation.
How a Testamentary Discretionary Trust Provides Flexibility for Beneficiaries
Upon the death of the Willmaker, testamentary discretionary trusts can be established by each primary beneficiary for their respective share of the estate. Most commonly, each primary beneficiary has a separate trust for their share of the estate, of which they are the Trustee and Appointor. A trustees can distribute income and capital to beneficiaries at their discretion, and as the Appointor, they retain ultimate control of the trust, including the ability to ‘hire and fire’ the Trustee. Diagrammatically, the structure of a testamentary discretionary trust is shown below:
Asset Protection Under a Testamentary Discretionary Trust
A well drafted testamentary discretionary trust (TDT) can ensure the inheritance left to your loved ones is better protected from third parties. A TDT can ensure that the inheritance you left to your loved one is not lost, in the event your loved one experiences one of the below life events:
- A marital or de facto relationship breakdown
- Enters into bankruptcy
- Is being sued in their professional capacity
- Becomes mentally incapacitated and cannot manage their affairs (either through dementia or an acquired injury).
If anything like the above occurs, the following strategies can ensure the assets held in the testamentary discretionary trust can’t be clawed back by creditors or given to former partners in a family law proceeding.
- Automatic provisions removing control of the TDT from the beneficiary in the event they suffer a “life event”. (Note that the courts will still consider it an asset available to the beneficiary when dividing assets and make adjustments.)
- Allowing beneficiaries to loan funds from the TDT to themselves and secure mortgage over a property or other assets which are to be repaid in the event of a life event.
Tax Minimisation With a Testamentary Discretionary Trust
The tax savings that can be achieved by using a testamentary discretionary trust will depend on the individual circumstances of the Willmaker and their family members, including the tax position of their adult beneficiaries, how many children under 18 those beneficiaries have and the tax position of those children. Here’s a simple example to make sense of it.
Tax Payable Without a Testamentary Discretionary Trust
William is an army officer and earns $250,000 per annum, so any further income received by him will be taxed at the highest marginal rate of 45% plus Medicare levy of 2%.
If Kate left her $2,000,000 estate to William outright (i.e. not in a testamentary discretionary trust) and he invested the full amount and generated a $120,000 income annually, then William’s after-tax position would be:
Income | $120,000 |
Tax and Medicare Levy | $56,400 |
Net Income | $64,600 |
Tax Payable With a Testamentary Discretionary Trust
Let’s say Kate had a great Estate Planning lawyer and created a testamentary discretionary trust, which William became the trustee of. William as trustee could distribute the same $120,000 of investment income to their three minor children who don’t earn any other income. Under a testamentary discretionary trust, minor children are taxed at the current adult marginal rates. This means that With the trust income distributed equally between Kate and William’s children, the after-tax position would be:
George | Charlotte | Louis | Combined | |
Income | $40,000 | $40,000 | $40,000 | $120,000 |
Tax | $4,367 | $4,367 | $4,367 | $13,101 |
Net Income | $35,633 | $35,633 | $35,633 | $106,899 |
The TDT saves $42,299 tax per annum, leaving more available to spend on the children’s education and welfare.
Talk to Our Estate Planning Lawyers About Including a Testamentary Discretionary Trust in Your Will
The estate planning process involves numerous key tools and strategies to protect yourself during your lifetime, and when you’re gone. To protect yourself during your lifetime, you should appoint an Enduring Power of Attorney (Financial and Personal) and a Medical Treatment Decision Maker.
To protect your wishes when you pass, you need a water-tight Will. BlueRock’s estate planning lawyers can help you plan for the future by creating a bespoke estate plan based on your needs. (And it’s not just for the uber-wealthy!) Fill out the form below and we’ll be in touch to book in a free consultation with one of our dedicated estate planning lawyers.
Disclaimer: The information in this article is intended as general information only and should not be considered as advice on any matter and should not be relied upon as such. This information has been prepared without taking into account any individual objectives, financial situation or needs. You should therefore consider the appropriateness of the information before acting or seek advice before making any financial decisions.
