Why you should think about a testamentary trust

You don't have to be ultra wealthy to get the benefits of a testamentary trust, explains Richard Livingston.

Key Points

  • What is a testamentary trust?
  • Offers potential benefits to a wide range of investors
  • We highlight pitfalls to be avoided

discretionary trust with an individual, a group of individuals or a company appointed as trustee. We prefer a company for the same types of reasons we set out in Why your SMSF needs a corporate trustee. But if your SMSF uses a special purpose trustee company you’ll need to set up a new company (costing you $500-$700 to set up and about $236 a year in ASIC fees, at current rates).

If you’re intending to make a death benefit payment from super and want the tax concessions available for death benefits dependents (see box) then you’ll need to establish a superannuation death benefits trust. So long as the beneficiaries of the trust are all death benefits dependents then the normal tax concessions apply.

What’s a death benefits dependent?

A death benefits dependant, of a person who has died, is:

(a)  the deceased person's spouse or former spouse; or

(b)  the deceased person's child, aged less than 18; or

(c)  any other person with whom the deceased person had an interdependency relationship just before he or she died; or

(d)  any other person who was a dependant of the deceased person just before he or she died.

If you’ve got a mixture of ‘dependent’ and ‘non-dependent’ beneficiaries you might consider multiple testamentary trusts. This makes sure the tax concessions don’t get lost.

Once you’ve worked out what you need, established a trustee company and drafted the first set of documents, there’s relatively little additional cost in establishing another trust.

The basic operation of the trust is that the trustee will manage the investments and make distributions to beneficiaries as set out in the trust deed. On the assumption you trust your trustee to do the right thing, it makes sense to give them as much flexibility as possible. For instance, tax is minimized if they can distribute capital gains to beneficiaries with capital losses or foreign income to those based overseas.

A few other key points to note:

  1. It’s possible to make the establishment of a testamentary trust ‘optional’ in the sense that you leave it up to your executor to decide if one is necessary and the terms required (minimising the cost involved now) or you give them the power to veto the trust you’ve specified (and paid for).

  2. You can get very creative with trusts. We’ve mentioned a typical structure but you could have a fixed trust (where you specify how income is to be distributed) or a trust where the income is used for a specific purpose (for example, a child’s school fees) and the capital balance of the trust reverts to someone else when the purpose is complete.

When it comes to testamentary trusts, the world is your oyster, but as ever there are some things to look out for.

The pitfalls

Taking shortcuts and getting it wrong we’ve mentioned, but there’s some other pitfalls to be aware of:

  1. The trustee. The major catch with using a testamentary trust is the need for a trustee. If you use a corporate trustee you might want it to have two directors. So you’ll need to be able to find two trusted friends or family members who have the skills to manage your assets and are happy to dedicate the time to the cause.

  2. Costs. Depending on the complexity of your situation, a testamentary trust might cost you $1,500 to $5,000 upfront (or more). There’s also the ongoing cost of accounts and tax returns (which will depend on the nature of the investments). This is the other major factor in assessing whether a testamentary trust is worth it. Remember that testamentary trusts can also be left as an ‘optional extra’ for your executor if you want to minimize upfront costs.

  3. Trade-off between control and flexibility. There’s a lot of guesswork involved in establishing the terms of a testamentary trust today – circumstances and the rules might change in the future – so you could end up with a less than ideal trust (especially when it comes to tax planning). On the flipside, leaving it up to your executor (or the beneficiaries) to decide at the time on the optimal arrangement limits your control of, for instance, wayward spending habits. Finally, you need to consider the cost of establishing the detailed terms of the trust today.

  4. Tax law changes. Taxation of trusts is an area that is constantly subject to speculation about change. So you need to make a testamentary trust that works not only today, but also in the future. For instance, you may need to make sure your trust can elect to become a ‘family trust’ to get favourable tax treatment.

As we said earlier, whether a testamentary trust makes sense and the best approach depends on your personal circumstances and views, so it’s critical that you take professional advice.

A surprising conclusion

If you’ve never considered a testamentary trust you might be surprised how much you (or your family) could benefit from one. Simply giving your executor the option of setting one up might not cost you much and give your beneficiaries plenty to gain.

 

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