The main advantages of including a testamentary trust in your Will are the tax advantages resulting from income splitting and the protection of your assets from legal claims or misuse.
Tax advantages
Discretionary Trusts that have a wide range of beneficiaries which allows the Trustee to exercise their discretion when distributing the trust income. This allows the Trustee to take a beneficiary’s tax circumstances into account.
A trust is required to pay tax on any undistributed income of the trust but is not required to pay tax on any distributed income. The Trustee can choose to distribute as much of the income of the trust as possible amongst the beneficiaries of the trust and can distribute the income in a way that takes the best advantage of each beneficiary’s personal marginal tax rate. The beneficiary then pays the tax on the distribution personally at their tax rate. This is called “income splitting”.
The tax advantages are particularly significant for distributions to minors who, according to the Australian Taxation Office, will be taxed at the adult marginal tax rate on any distributions received from the trust rather than the usual penalty rate of tax for a minor.
Asset protection
Testamentary Trusts can also be used to protect your assets after your death. This is because the legal owner of the assets is the Trustee and not the beneficiary.
This difference in ownership can make it less likely that the assets would be open to division if the beneficiary is subject to family law proceedings or becomes bankrupt. In family law proceedings, the assets held in the trust would only be likely considered a financial resource of the beneficiary and not necessarily open for division with their former spouse. In the case of bankruptcy, trust assets are ordinarily considered exempt from payment of creditors.
If the control of the trust is held by someone other than the beneficiary, the Trustee can maintain the assets of the trust for the benefit of the beneficiary while also ensuring that the assets are protected from waste if the beneficiary is experiencing a problem such as gambling or drug addiction.
Testamentary Trusts can also be useful for beneficiaries with an intellectual disability who cannot manage their own funds. You are able to appoint someone to manage their funds on their behalf with conditions to ensure your beneficiary’s inheritance is looked after. If your Will includes a beneficiary with an intellectual disability you might also consider establishing a special type of trust call a Special Disability Trust.