Estate planning is a fundamental step in securing the financial future of your loved ones. One effective tool available under Australian law is a testamentary trust. These trusts provide asset protection, tax benefits, and control over inheritance distribution, making them a preferred choice for many Australians.
With increasing concerns over divorce settlements, bankruptcy risks, and tax implications, testamentary trusts offer a practical way to ensure that your estate is distributed according to your wishes while protecting beneficiaries from unforeseen financial risks.
This article explores everything you need to know about testamentary trusts in Australia, including how they work, their advantages and disadvantages, and key legal considerations.
Let’s Get Straight to the Point
For those who want the quick version, here’s a summary:
- What is a Testamentary Trust? A trust is created through a will, activated upon death, and holds assets for beneficiaries.
- Who Needs One? Australians looking for tax advantages, asset protection, and controlled inheritance distribution.
- Main Benefits: Protects assets from divorce, creditors, and bankruptcy while offering tax-efficient distributions.
- Drawbacks: Requires administration, legal costs, and ongoing trustee management.
- Key Update: Testamentary trusts remain highly effective for tax planning but require careful structuring to ensure compliance with recent legal updates.
What is a Testamentary Trust?
A testamentary trust is a discretionary trust established through a will and taking effect upon the will-maker's death. Instead of distributing assets directly to beneficiaries, the estate is transferred to a trustee, who manages and distributes assets according to the terms set in the will.
Key Features of a Testamentary Trust
- Established through a will and only becomes active after death.
- Trustees control asset distribution instead of beneficiaries receiving lump sums.
- Can last for up to 80 years, benefiting multiple generations.
- Offers tax advantages and protection from financial risks such as bankruptcy or divorce.
Why Australians Use Testamentary Trusts
Asset Protection
Protection in Divorce Settlements
In Australia, assets gifted outright to a beneficiary can be included in divorce settlements. However, assets held in a testamentary trust are not directly owned by the beneficiary, making them less likely to be considered in family law disputes.
Shielding Against Bankruptcy and Creditors
If a beneficiary faces financial difficulties or becomes bankrupt, creditors cannot claim creditors cannot claim assets in a testamentary trust. This ensures that wealth remains protected for future generations.
Safeguarding Vulnerable Beneficiaries
A testamentary trust can be beneficial for:
- Children or grandchildren with disabilities who need long-term financial support.
- Beneficiaries with addictions, mental health issues, or poor financial management skills.
- Ensuring inheritance isn’t lost through mismanagement.
Tax Benefits of Testamentary Trusts
Lower Tax Rates for Minor Beneficiaries
Under Australian tax law, children under 18 who receive distributions from a testamentary trust pay tax at adult rates rather than the penalty 66% rate applied to normal trust distributions. This can result in significant tax savings for families.
Income Splitting Benefits
Trustees can distribute income to multiple beneficiaries, ensuring that lower-income family members receive more taxable income, reducing the overall tax burden.
Capital Gains Tax (CGT) Advantages
Testamentary trusts allow for capital gains tax (CGT) streaming, which means capital gains can be distributed in a way that minimises tax liabilities.
Control Over Inheritance Distribution
Multi-Generational Planning
A testamentary trust can preserve wealth for up to 80 years, allowing it to be preserved across multiple generations.
Prevention of Poor Financial Decisions
Beneficiaries cannot recklessly spend their inheritance by holding assets within a trust. Instead, the trustee controls distributions based on set conditions.
How to Set Up a Testamentary Trust in Australia
Drafting a Will with Testamentary Trust Provisions
The will must specify how the testamentary trust will operate, including:
- Who the trustee(s) will be.
- Who the beneficiaries are.
- How income and assets will be distributed.
Choosing the Right Trustee
A trustee controls the trust’s assets, making their selection a critical decision. Options include:
- A trusted family member (must be financially responsible).
- A professional trustee (such as a lawyer or accountant) to ensure impartial management.
Compliance with Australian Trust Laws
Recent legal updates highlight the need to:
- Ensure tax compliance – distributions must align with the Australian Taxation Office (ATO) guidelines.
- Consider pension eligibility – Centrelink may assess trust distributions when determining pension entitlements.
Potential Drawbacks of Testamentary Trusts
Ongoing Administration and Costs
Testamentary trusts require annual tax returns and professional management, which can be costly. Expenses include:
- Tax compliance and accounting fees (typically $1,500–$5,000 per year).
- Legal costs for trust setup and maintenance.
- Trustee fees, especially if using a professional service.
The benefits outweigh the costs for larger estates, but for smaller estates, a simple will may be more practical.
Disputes Over Trustee Control
Since trustees have full discretion over distributions, conflicts may arise when:
- Beneficiaries disagree with distribution decisions.
- Perceived favouritism creates family tension.
- A lack of transparency leads to mistrust.
Choosing an independent trustee can help prevent disputes.
Impact on Government Benefits
Trust distributions may reduce Centrelink payments, such as the age pension or disability support pension.
- Trust income is included in the income test, potentially lowering benefits.
- Careful structuring can prevent unintended financial loss.
Seeking estate planning advice ensures the trust aligns with Centrelink regulations.
Is a Testamentary Trust Right for You?
A testamentary trust is ideal for Australians who want to protect their wealth, reduce taxes, and control their inheritance. However, it is not necessary for everyone.
Who Should Consider a Testamentary Trust?
- Significant assets – Ideal for estates with real estate, investments, or businesses.
- Tax savings – Income can be split among beneficiaries to reduce tax liabilities.
- Asset protection – Shields wealth from divorce settlements, creditors, or bankruptcy.
- Financially vulnerable beneficiaries – Provides structured support for children, disabled family members, or those with poor financial habits.
- Blended families – Ensures assets are distributed fairly between different family members.
Who Might Not Need One?
- Small or simple estates – The cost of administration may outweigh the benefits.
- No asset protection concerns – An outright inheritance may suffice if beneficiaries are financially stable.
- Avoiding complexity – Testamentary trusts require ongoing management, tax filings, and trustee oversight.
- Minimal tax benefits – Tax savings may be limited if beneficiaries already have high incomes.
A testamentary trust offers long-term financial security, tax efficiency, and inheritance control, but it’s best suited for larger or complex estates. If unsure, consult an estate planning lawyer to determine if it aligns with your family’s needs.
Key Takeaways: Testamentary Trusts
Testamentary trusts remain a powerful estate planning tool but require careful management and legal compliance.
Tax Savings and Asset Protection
- Income splitting helps reduce tax liabilities, especially for minors.
- Protects assets from divorce settlements, creditors, and financial mismanagement.
Best for Minors, High-Risk Professionals, and Blended Families
- Minors benefit from lower tax rates and structured financial support.
- High-risk professionals protect their inheritance from lawsuits or liabilities.
- Blended families ensure fair distribution across multiple marriages.
Requires Ongoing Management
- Allows controlled inheritance distribution, preventing reckless spending.
- Requires trustee oversight, annual tax returns, and legal compliance.
Choosing the Right Trustee is Critical
- A family member may be suitable but could lead to conflicts.
- A professional trustee ensures impartial management but comes with fees.
Legal Updates Require Careful Structuring
- ATO regulations require proper tax planning for distributions.
- Centrelink benefits may be affected, so structuring is important.
- Consulting an estate planning expert ensures compliance.
Testamentary trusts offer tax efficiency, asset protection, and inheritance control. However, to remain effective, they require careful planning and professional guidance.
Conclusion
Testamentary trusts will remain a powerful estate planning tool for Australians. Whether you want to protect assets from creditors, minimise tax burdens, or provide structured inheritance for your family, they offer a reliable and flexible solution.
If you’re considering a testamentary trust, consult an estate planning lawyer to tailor a strategy that fits your financial and family situation. Proper planning today can provide security for future generations.
The cost of setting up a testamentary trust varies depending on legal fees and estate complexity. Typically, it ranges from $3,000 to $6,000 in lawyer fees, plus ongoing administrative costs like accounting and tax filings.
A testamentary trust is created when the will-maker dies, but finalising probate and activating the trust can take 6-12 months. The timeframe depends on court processing times and estate complexity.
The trustee controls the assets and manages distributions according to the terms of the will. A trustee can be a family member, lawyer, or professional trust company. The trustee ensures that assets are protected and distributed as intended.
Yes, trust distributions may be counted as income when assessing Centrelink eligibility. To avoid losing pension or disability benefits, the trust should be structured carefully to minimise financial impact.
Testamentary trusts are most beneficial for large estates or those where asset protection and tax savings are priorities. However, the costs and complexity outweigh the benefits for smaller estates, so a simple will is a better option.
