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The Concept

The Testamentary Trust involves a trust in a Will which will secure significant asset protection while offering tax advantages for beneficiaries of your estate.

The concept is a result of section 102AG of the Income Tax Assessment Act 1936 (incorporated in the 1997 Act).  This section removes the punishing rates of tax on unearned income (interest, investment dividends, etc) for children and allows ordinary tax rates to apply where the income is distributed from a trust estate created under the Will of a person; hence the name “Testamentary Trust”.

The Problems

The tax problem: on a person’s death, the “usual” situation under a “standard” Will is that:

1. all assets are left to the surviving spouse and on the spouse’s death, to the children;
2. the spouse’s tax free threshold is $6,000;
3. children’s individual tax free threshold (without low income rebate) is $750 each; and
4. the spouse invests the assets and “distributes” income in the most effective way.

In effect, this means that without a Testamentary Trust, and assuming three children in the family, a maximum of $8,250 income per annum can be earned without paying tax.

The asset protection problem: under a "standard" Will assets are often distributed to the deceased's children who then own those assets.  If such a child is involved in a family law dispute those assets are exposed to claims by the spouse and may even be shared by the spouse's children from another relationship.  Creditors can also claim against your child's assets (which include your former assets) - as to which see further below.

It means therefore that you are not protecting your own children from the common problems in life.
 

The "Simple Will"
Assets in Estate
Surviving Spouse - Sole Beneficiary
Income from Invested Estate Assets
Spouse $6,000	Child 1 $750	Child 2 $750	Child 3 $750

What Does This Mean?

That, without proper planning, a family is left with a tax free threshold of $8,250 and pays tax on the excess.  This equates to only $158.65 tax free per week for this family.

By not putting in place a Testamentary Trust, a major beneficiary of your estate will be the Australian Tax Office at the expense of your family.

One Solution - Testamentary Trust

However, using a Testamentary Trust means a maximum of $24,000 can be earned without paying tax (using threshold rates effective 1 July 2008).

Assets in Estate
Testamentary Trust in Will
Income from Invested Estate Assets in Testamentary Trust
Spouse $6,000	Child 1 $6,000	Child 2 $6,000	Child 3 $6,000

In this example, the introduction of a Testamentary Trust provides the family with an additional $15,750 per annum tax free or an extra $302.88 a week tax free.

Asset Protection

If your assets are gifted to your children so that your children own them, third parties (creditors) may claim against those assets.

If, however, assets are gifted to a testamentary trust over which your spouse or your surviving children have control, then because the trust owns the assets and not the children, third parties will have greater difficulty accessing the assets.

Conditions may be imposed on how and when the trust makes distributions to the trust beneficiaries (your spouse and/or children) which your spouse and/or children themselves control.

A standard Will gives no protection at all; a Will with a testamentary trust gives control to your surviving spouse or surviving children but does not gift assets to them so that these assets may be protected from third party claims.

Tax Rates 2010-11
Taxable income	Tax on this income
0 - $6,000	Nil
$6,001 - $37,000	15c for each $1 over $6,000
$37,001 - $80,000	$4,650 plus 30c for each $1 over $37,000
$80,001 - $180,000	$17,550 plus 37c for each $1 over $80,000
$180,001 and over	$54,550 plus 45c for each $1 over $180,000