Estate Planning - Trusts Created By A Will Funded By The Will Maker - Part 2: What is a Testamentary Trust?

Other articles in this series

• Estate Planning - Trusts Created By A Will Funded By A Will Maker - Part 1: The Will
• Estate Planning - Trusts Created By A Will Funded By A Will Maker - Part 3: Types of Testamentary Trusts

What Is A Testamentary Trust?

Simply, a testamentary trust is a trust established by a will. Testamentary trusts can be mandatory or optional, fixed or non-fixed, flexible or protective, short or long-term, or charitable or non-charitable. Testamentary trusts can also operate for as long as the beneficiary is less than 18 years of age. Testamentary trusts can also provide asset protection and taxation advantages for beneficiaries.   The testamentary trust also enables the executor/trustee to block or restrict access to capital for a lifetime or other time period.   This mechanism is called fixed or flexible life interests.   Testamentary trusts also enable the executor to provide needy or vulnerable beneficiaries with ongoing financial support. 

Income tax concessions also apply to fixed and non-fixed testamentary trusts. These concessions allow individual beneficiaries under 18 years receiving trust income to be taxed at the lower marginal tax rates normally reserved for adults. Unlike companies, fixed and non-fixed trusts qualify for the same 50% capital gains tax discount rules applicable to individuals. 

It is vital that the will maker clearly sets out in his/her will the terms of each of the different types of testamentary trusts, how they are to be administered, and the extent of trustee discretion.   There are a wide variety of testamentary trusts established instead of the traditional immediate or eventual outright bequest (of personal property) or devise (of real property) to the primary beneficiary. There are a wide range of testamentary trusts, including:

• To protect the surviving domestic partner/child faced with the prospect of a contested estate;
• To provide for children or relatives to share an estate;
• To provide for primary beneficiaries faced with difficult family or domestic circumstances;
• To provide for infant beneficiaries yet to reach the required age of 18 years age;
• To provide for beneficiaries facing bankruptcy; and
• To provide for beneficiaries who have lost or are likely to lose decision-making capacity.

One of the greatest benefits of creating a testamentary trust in a will is the will maker’s ability to give the executor flexibility regarding the form of the testamentary trust. The will maker does this by giving the executor a menu of options. The will maker can make certain that whenever a beneficiary should not benefit from a testamentary trust, there is an option for the executor to avoid creating the trust in the first place, be selective about which assets are held in a testamentary trust, choose a particular form of testamentary trust (e.g. split fixed as opposed to fully discretionary), choose from a narrower class of beneficiaries or establish multiple testamentary trusts. 

Non-fixed Testamentary Trusts

The principal advantages of non-fixed testamentary trusts are as follows:

• Protection to beneficiaries in relation to breakdown of relationships;
• Income splitting with children or grandchildren; and
• Avoiding challenges to the beneficiary’s own estate.

Non-fixed trusts, however, are subject to restrictions in relation to the carrying forward or claiming of income losses.

Fixed Testamentary Trusts

Fixed testamentary trusts, on the other hand, do not offer all of the advantages of non-fixed trusts. Fixed testamentary trusts can qualify for certain tax and other concessions. Examples are the CGT main residence exemption and land tax exemptions or concessions.

There are a number of categories of testamentary trusts as follows:

• Absolute – where an inheritance passes as an outright gift to an adult beneficiary as the administration of the deceased estate is completed;
• Defeasible – where prospective outright beneficiary trusts are created where control or ownership passes if and when certain age is attained;
• Contingent – education testamentary trusts;
• Fixed life interests – for a surviving domestic partner;
• Rights of occupation – of a family home or other real estate;
• Capital reserved (or capital) – where capital protected testamentary trusts are created with a lifetime principal beneficiary and the class of alternate potential income beneficiaries;
• Capital reserved (residual capital only) – where special disability trusts or protective trusts are created with a lifetime principal beneficiary and the class of alternate potential income beneficiaries;
• Charitable;
• Fully discretionary with a narrow class of beneficiaries – a superannuation death benefits testamentary trust is an example; and
• Fully discretionary with a wide class of beneficiaries – a single or staggered release beneficiary controlled testamentary trust is an example.