Testamentary trusts can be a popular topic of conversation. The use of testamentary trusts, and whether it is still appropriate and tax effective to utilise them in estate planning comes up every now and then. It is usually around an election, when the Government of the day is proposing changes to tax laws that may affect testamentary trusts. Let’s get some perspective on this issue. What are the potential ‘tax benefits’ of including a testamentary trust in your Will?
First, your executors and trustees gain some flexibility to determine where your assets ultimately end up. Rather than fixing in stone who will benefit from each particular asset in your estate, the trustee of a testamentary trust can have some ‘discretion’ to allocate assets among a range of potential beneficiaries after you have died. This can potentially defer an otherwise immediate CGT liability and save on stamp duty (where applicable) when it comes to administering your estate and deciding who gets what assets.
Secondly, if a residential property passes to a testamentary trust and the property is occupied by a beneficiary, then the property can benefit from land tax relief in most states, and ultimately pass to the beneficiary without triggering an immediate CGT liability.
Finally, any arm’s length income of the trust can be distributed to beneficiaries who are under 18, and those children can claim the tax-free threshold and lower marginal rates of tax. This can be contrasted with distributions from ‘ordinary’ trusts (i.e. trusts not set up under a Will), where income received by a child will be subject to the top marginal rate of tax from the get-go.
So yes, there are several potential tax benefits associated with a testamentary trust if the circumstances line up.
But why do these benefits exist at all? Because someone needs to die to bring the trust into existence – and most people don’t die to gain access to potential tax benefits for their heirs.
Further, what would happen if these ‘benefits’ were not available?
Well, the children of the deceased would end up paying a penalty rate of tax on the income earned from the deceased’s assets that have been left to support them. Land tax would be payable that would ordinarily not be payable if a residence did not need to be held in a trust for a minor. So the ‘benefits’ associated with a testamentary trust are really not ‘benefits’ – they are more of an ‘avoidance of a penalty‘. The status of a testamentary trust puts your beneficiaries back in the position that they would be in if you had not died.
This is why the policy exists to relieve testamentary trusts from the penalty tax regime ordinarily applicable to child trust beneficiaries.
But, most importantly, we almost never recommend the use of a testamentary trust for its potential tax benefits. In every case where we have recommended a testamentary trust over the past 17 years, it has been because of the ability to protect the legacy from unjust claims and to restrict when a beneficiary gains control over the assets to an age when they are likely to make good decisions. The tax treatment of a testamentary trust means that we can achieve these very legitimate and sensible estate planning objectives without incurring a tax penalty.
The Government loves to meddle with our taxation laws. Over the years, Governments have proposed changes to tax law, which might see the way that testamentary trusts are taxed. To date, no material changes to the law have been implemented that change how we feel about using testamentary trusts in estate planning. Time will tell. But meanwhile, it is our view that nothing changes on the estate planning front with respect to our very legitimate and conservative use of testamentary trusts in your estate planning strategies.
The information contained in this post is current at the date of editing – 5 May 2023.