A testamentary discretionary trust is simply a discretionary trust established by a will. It is also sometimes called a protective trust, or a family trust. However, although the term ‘family trust’ is often used in a general sense to mean testamentary discretionary trusts which provide benefits for the family of a testator, a ‘family trust’ is also a specific vehicle for taxation purposes, whether created by a will, or inter vivos.
For any trust to be a ‘family trust’ for taxation purposes – and therefore gain more beneficial treatment – a family trust election must be made for tax purposes. A testamentary discretionary trust can also be established for the benefit of non-family members, or even organisations such as charities – but the benefits, especially tax concessions, are fewer where family members are not the beneficiaries and the exercise is therefore usually less worthwhile.
Testamentary discretionary trusts can protect assets from any creditors of beneficiaries in the event that they are sued, or become bankrupt, as the asset will be held by the trustee, not the beneficiary. Such trusts may also avert family provision claims against the estates of deceased beneficiaries, as again beneficiaries will have no personal ownership of assets. There is also some degree of protection of assets and income held for a beneficiary in a testamentary discretionary trust from any spouse of that beneficiary if they become involved in family law proceedings.
Testamentary discretionary trusts also provide a means of accessing favourable taxation treatment by ensuring all beneficiaries use their income tax free thresholds. In relation to losses and franking credits a family trust election can secure tax advantages otherwise unavailable, provided that the trust passes the family control test and makes distributions of trust income only to beneficiaries of the trust who are members of the family. For testamentary discretionary trusts which are not family trusts, flexibility as to when and to whom to distribute income can still provide tax advantages. The tax benefit of a testamentary discretionary trust as against an inter vivos trust is that distribution of income to minors is taxed in the hands of minors at normal marginal rates. They therefore get the benefit of the tax-free threshold and the low rates of tax enabling payment of their school and other expenses either tax free or with little tax. An elderly testator with six young grandchildren can provide significant tax savings to the parents of those children in this way.
Testamentary discretionary trusts are not appropriate for many – perhaps most – clients. Unless the extent and complexity of the testator’s assets, or the size and complexity of the testator’s estate, warrants it, the trouble and expense involved in establishing and administering such trusts may not be worthwhile. It is however important to fully explore the issues with clients when they are contemplating making a will so that any current or future need for a discretionary testamentary trust can be assessed, which means considering their family members, their current and future financial circumstances – do they expect to receive a substantial inheritance, for example – and their existing family arrangements including with respect to any businesses, companies or existing trusts.
Testamentary discretionary trusts can be created for all assets and beneficiaries of the estate, or multiple testamentary discretionary trusts for multiple beneficiaries. They can also be used to establish additional testamentary discretionary trusts to provide protection for specific assets such as quarantining a family business or to allow for the particular needs of an individual beneficiary due to say drug or alcohol addiction.
Please note that this memorandum is not legal advice but may help you understand the law. If you have a query regarding testamentary discretionary trusts, contact our dedicated team at Kenmore Mediation and Law Centre on (07) 3378 4006, or at email@example.com