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Testamentary Trusts (NSW)

A will typically contains provision for the distribution of a testator’s deceased estate after their death. There are some instances where a testator might choose to create a testamentary trust instead of bequeathing an asset directly to a beneficiary. There are benefits from creating this type of trust, including tax advantages. Trusts can be used to protect assets or income, and provide security for those who are not able to manage their own affairs. This article defines the nature of a testamentary trust and lists the benefits of establishing such a trust in a will.

What Is A Testamentary Trust?

A testamentary trust is an estate planning structure that allows a testator to provide for a beneficiary without giving them direct access to their bequest. A testamentary trust usually comes into force upon the death of the testator. A trust can be discretionary, where the beneficiary has power to choose to take some or all of their inheritance as a trust in the first place and to appoint or remove trustees. Alternatively, a testamentary trust can be protective, where the beneficiary has far less control over the trust. In a protective trust, beneficiaries can only take their inheritance in the form of a trust and have no authority over the appointment of trustees. This trust is commonly established to protect vulnerable beneficiaries, such as those with a cognitive disability or those who are in danger of wasting their inheritance because of addiction. Some testators establish terms of a trust that must be met before the beneficiaries can access the trust funds, such as getting married or reaching a certain age.

The testator selects a trustee to oversee the distribution of the trust’s assets to the beneficiaries. A trustee can be an organisation, such as the NSW Trustee and Guardian, or an individual that the testator trusts to carry out their last wishes. With a discretionary trust, a trustee has full discretion to decide who benefits in what proportion under the trust. A testator can establish as many trusts in a will as they wish: ideally, each beneficiary will have a separate trust.

Benefits Of A Testamentary Trust

There are a number of advantages to establishing a testamentary trust in a will.

One major benefit of a discretional testamentary trust is that income gains, franked dividends and capital gains can be distributed to family beneficiaries annually in the most tax-efficient manner. Tax concessions apply to both income and capital gains from inherited assets and any gains derived from new assets bought through the reinvestment of trust funds.

There are tax advantages to income splitting a testamentary trust benefit. A beneficiary of the trust can apportion the income they derive from the trust assets to other beneficiaries. For example, trust income can be diverted to children for the payment of school fees and those funds will be taxed at a lower tax rate than would otherwise apply to trust funds.

A protective testamentary trust is designed to provide for any beneficiary who cannot manage his or her own financial affairs. This may apply to a minor child who cannot make legal and financial decisions for themselves, but it is also often used when an adult has a history of addiction or criminal behaviour. Protective trusts are also used for the long-term care of beneficiaries who have psychological disorders or mental illness or disability.

A testator can ensure that their children or grandchildren receive a suitable education through an education fund established in a testamentary trust. This is a tax-effective and adaptable method of planning for the future and ensures that the funds that the testator earmarked for this purpose are not used for any other purpose.

A testamentary trust also provides asset protection from divorce, remarriage or legal liability. Depending on the structure of the testamentary trust, it usually provides some protection from creditors, as a creditor cannot recoup a beneficiary’s debt from a trust without a court order.

Can A Will With A Testamentary Trust Be Contested?

In NSW, there is provision under the Succession Act 2006 for eligible people to file a Family Provision Claim if they have not been fairly and adequately provided for in the deceased’s will. The Supreme Court can reclaim assets that have been designated as part of a testamentary trust for redistribution to beneficiaries and claimants.  The court is more likely to do so if there is evidence that the testator created the trust in a deliberate attempt to avoid their moral duty to provide for dependents and other entitled parties.

A testamentary trust is a complicated legal instrument and must be created by a solicitor with expertise in this area of law. The contested wills team at Armstrong Legal has a wealth of experience in all areas of testamentary law and can help you establish or contest a testamentary trust. Please do not hesitate to call or contact our offices to make an appointment.

Dr Nicola Bowes

This article was written by Dr Nicola Bowes

Dr Nicola Bowes holds a Bachelor of Arts with first class honours from the University of Tasmania, a Bachelor of Laws with first class honours from the Queensland University of Technology, and a PhD from The University of Queensland. After a decade working in higher education, Nicola joined Armstrong Legal in 2020.

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