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The pros and cons of testamentary trusts at a glance:

1. Trusts don’t have to pay tax on income that is distributed to beneficiaries.
2. The trustee has the discretion to distribute income to as many beneficiaries as possible.
3. Tax concessions for testamentary trusts aren’t limited to income and capital gains from assets that exist in the trust at the time of your death.
4. In most cases, there will not be any tax due on the transfer of your assets to your executor and then to your testamentary trust.
5. Depending on the state you live in, however, there could be capital gains tax on assets acquired for the trust by the trustee after your death.
6. There may be tax implications for the exemption from capital gains tax on your residence if it’s held in the testamentary trust.
7. Ongoing administrative expenses, such as accountancy fees and tax preparation services, will reduce the amount of assets in your trust.
8. The trust has to pay tax on undistributed income.

If you’re working on your will and trying to decide the best way to provide for your loved ones after your death, you might want to explore testamentary trusts. A testamentary trust is created by your Will, and is a useful vehicle in your overall estate planning strategy. It doesn’t come into effect until after you die, and it gives full discretion of your distributions to a trustee.

Before we look at the pros and cons of testamentary trusts, let’s look at seven situations in which testamentary trusts may be useful.

1. High-Risk Beneficiaries        

If one or more of your beneficiaries is in a high-risk profession (firefighter, police officer, active military, etc.), or if your beneficiaries have a business in which negligence claims are likely, you might want to consider a testamentary trust.

2. Creditor Protection

Testamentary trusts offer some protections to bequests from your beneficiaries’ creditors. It can also protect your beneficiaries by making sure their inheritance is not susceptible to their spouses’ business debts.

3. Education

For people who want to leave money for their grandchildren’s schooling (including boarding school and tuition and fees), a testamentary trust can be a tax-effective way of achieving this goal.

4. Divorce of a Child

Since assets that are held in the trust are not assets belonging to any one individual, the Family Court cannot make an order requiring the distribution of those funds. Therefore, a testamentary trust can be an effective way of making sure your divorced child receives his or her inheritance.

5. Remarriage of a Spouse

Some people are concerned that if their surviving spouse remarries, the estate will be diverted to the new family or that the estate could be squandered in unprofitable ventures at the new spouse’s suggestion. A testamentary trust is a good vehicle for making sure this doesn’t happen.

6. Children with Issues

Some children are more trustworthy than others. If you have a child who is a spendthrift or has tendencies toward gambling or drug addiction, using a testamentary trust can be a good way to make sure this child’s share is kept intact.

7. Disabled Children

A testamentary trust can be an effective management tool when you need to make sure that disabled or intellectually impaired children rely on your estate for their well-being.

Now that we know some of the conditions under which testamentary trusts can be particularly useful, let’s look at the pros and cons. There are many ways to structure your estate. By carefully looking at each one and seeing how it matches up with your personal situation, you’ll be more likely to make a good decision.

Pros of Testamentary Trusts

Most of the advantages of testamentary trusts lie in their structure. The separation of control and benefit allows these trusts to protect assets from legal action or people who would not make wise financial decisions. Your estate would be protected from bankruptcy and court orders, keeping it intact for your beneficiaries. Let’s take a look at a few more pros:

Tax Advantages

Reducing tax in estate planning is a worthwhile process. One of the biggest tax advantages of using a testamentary trust is the fact that income, capital gains, and franked dividends are distributed among your beneficiaries each year in a tax-efficient way. Trusts don’t have to pay tax on income that is distributed to beneficiaries, and this means your beneficiaries will get to enjoy more of the estate. The trust does, however, have to pay tax on undistributed income. 

The trustee has the discretion to distribute income to as many beneficiaries as possible, and these distributions can be personalised. For example, the trustee could distribute funds in proportions that take best advantage of each person’s marginal tax rate. Then the beneficiaries pay tax on their distributions. 

Tax concessions for testamentary trusts aren’t limited to income and capital gains from assets that exist in the trust at the time of your death. They also apply to income and capital gains derived from assets the trust acquires with the funds that existed in your original estate.

Pensions

Depending on your unique situation, there may be tax advantages for any of your beneficiaries who are eligible for a pension. This is because the assets of a testamentary trust are not accounted for when pension eligibility is established. Therefore, under the current means tested pension rules, they will still be eligible for the same amount, even though they’ll receive distributions from your estate.

Capital Gains Tax

In most cases, there will not be any tax due on the transfer of your assets to your executor and then to your testamentary trust. Additionally, there should be no tax on the cash proceeds of your life insurance policy or your super death benefit. 

This is also the case for assets that originally belonged to you. Depending on the state you live in, however, there could be capital gains tax on assets acquired for the trust by the trustee after your death.

Cons of Testamentary Trusts

Those are some pretty attractive advantages, but it’s wise to explore the disadvantages of testamentary trusts as well.

Taxes on the Family Home

There may be tax implications for the exemption from capital gains tax on your residence if it’s held in the testamentary trust. Check with your financial adviser to find out if this will be an issue for you.

Cost of Administering the Trust

If you decide to appoint a professional to be the trustee of your testamentary trust, there will be fees involved. Ongoing administrative trusts, such as accountancy fees and tax preparation services, will reduce the amount of assets in your trust.

For this reason, it’s important to consider this question: does the income generated from the estate warrant a testamentary trust? If you’re not sure, you can include a testamentary trust as an option in your Will. The trustee can later make the decision about whether it’s appropriate and feasible to implement the trust. 

As you can see, there are a lot of considerations to think about when determining whether or not a testamentary trust is right for your estate. For more information about testamentary trusts, or to speak with a Wealth Adviser about your personal estate planning, get in touch with us at Altus Financial.