Why every property investor needs a Testamentary Trust Will

From
Brian Hor

Brian Hor

Whether you just own your own home, or you have an expansive investment property portfolio, you need to have a Testamentary Trust Will.

A Testamentary Trust Will is simply a Will that contains one or more special trusts that act very much like a discretionary family trust that is only set up after you die. Like a family trust, the trust has someone who holds and controls the trust property (the Trustee) on behalf of a range of other persons who will benefit from the trust (the Beneficiaries). The trust is also discretionary, in that it is entirely up to the trustee to decide each year which one or more of the beneficiaries will receive any income generated by the trust assets, and who will receive the remaining assets of the trust when the trust eventually ends.

So, what are the advantages of having a Testamentary Trust Will?

First, flexibility. A simple old-fashioned Will divides a deceased person’s assets (their “estate”) into fixed shares (for example, between their children in equal shares). Easy and simple to understand – however, this will also mean that their children will pay tax on any income generated by their inheritance, at their own marginal tax rate (which could be up to 45% plus 2% Medicare Levy). Now, suppose instead that each child was able to receive their inheritance in a Testamentary Trust. This would mean that they could allocate the income from their inheritance each year between themselves and / or other family members, such as their spouse and their own children. It also means that they could allocate the assets in their trust flexibly as well between the different beneficiaries of their trust, depending on their individual needs. This flexibility allows for changes in personal circumstances so that distributions of income and assets can be made to suit each child’s needs from time to time.

Second, that inherent flexibility together with special tax concessions that apply to Testamentary Trust income gives rise to significant ongoing taxation benefits. Under section 102AG of the Income Tax Assessment Act 1936, any income received by a minor (aged under 18 years) beneficiary from a Testamentary Trust is treated as “excepted trust income” and taxed as if that beneficiary was an adult. This means that adult tax rates apply, so that the first $18,200 received by that beneficiary from the trust is tax free – every year. (This is unlike a normal family trust set up during your lifetime, where income paid to minor children from the trust over $416 per year attracts “penalty” tax rates of 66% up to $1,307, with the balance being taxed at 45%.)

For example, say Tom’s Will leaves two investment units directly to his wife Jill. Say they earn a combined rent of $50,000pa. If Jill is on the top tax rate, she will pay tax and Medicare Levy of $23,500 just on that income. However, if instead Tom’s Will leaves the units to a Testamentary Trust for his wife and 3 kids, if the kids earn no other income then the $50,000 rent can be split equally between them and they pay no tax at all – a saving of $23,500 in just one year.

If this situation continued for 10 years, the savings would add up to $235,000.

Third, by having assets held in a discretionary Testamentary Trust, each child’s inheritance is protected from lawsuits that might arise from their own business or profession, or from their creditors if they fall on hard times. This is because it cannot be argued that the child owns the assets, as they are just one of a number of potential beneficiaries of the trust who only get anything if the trustee says so. This also means that the assets of the trust are protected from the bankruptcy of any particular beneficiary of the trust. It can also provide meaningful protection of the trust assets in the event of the child experiencing a relationship breakdown, with the Family Court often treating the Testamentary Trust as a financial resource instead of part of the matrimonial property that is available for division by the Court.

The only drawbacks of having a Testamentary Trust Will are that it is usually more expensive to draw up than a simple old fashioned Will (although for many couples with children, the once-off legal fee could be less than just one year’s premiums for their top private hospital and extras health insurance), plus each year (after you die) the trust has its own tax return to lodge (that may cost around $1,500 – $2,000 per year). But if the tax savings are anything like in the above example, clearly the Testamentary Trust will more than pay for itself.
By Brian Hor,  Special Counsel – Estate Planning & Superannuation

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