What is a Testamentary Trust — and Do You Need One?

Most people have heard of a standard will — you leave your assets to your spouse, then your children. But a testamentary trust will does something far more powerful: it establishes a trust that only comes into existence when you die, and can provide significant tax and asset protection benefits for your beneficiaries for decades after you're gone.

Despite their advantages, testamentary trusts are poorly understood and rarely used outside of wealthy families with expensive legal advisers. This guide explains what they are, who should consider them, and why they're more accessible than most people think.

What is a testamentary trust?

A testamentary trust (sometimes called a TDT — testamentary discretionary trust) is a discretionary trust created by a will that takes effect on the death of the will-maker. Rather than leaving assets directly to beneficiaries, the will transfers assets to a trustee, who then manages and distributes them at their discretion among a class of beneficiaries (typically the spouse, children, and grandchildren of the deceased).

The key tax advantage: income splitting with minors

Under normal circumstances, trust income distributed to children under 18 is taxed at penalty rates (up to 66 cents in the dollar) under the so-called "kiddie tax" rules. This makes most family trusts ineffective for distributing income to minor children.

Testamentary trusts are a significant exception. Income distributed from a testamentary trust to minor beneficiaries is taxed at ordinary adult marginal rates — including the full tax-free threshold. This means a child can receive up to approximately $18,200 per year from a testamentary trust completely tax-free.

Asset protection benefits

A testamentary trust also provides significant asset protection for beneficiaries. Because assets are held in a trust rather than owned outright by beneficiaries, they are generally protected from:

• Bankruptcy — A beneficiary's creditors cannot access trust assets if the beneficiary is not a trustee
• Divorce — Trust assets are more difficult (though not impossible) for a beneficiary's former spouse to claim in family law proceedings
• Litigation — If a beneficiary is sued, trust assets are generally protected
• Spendthrift beneficiaries — The trustee can choose not to distribute to a beneficiary who is making poor financial decisions

Who should consider a testamentary trust?

Testamentary trusts are worth considering if:

• You have young children or grandchildren
• Your estate is likely to generate significant ongoing income (investment properties, share portfolios, business interests)
• You have beneficiaries in high income tax brackets who would benefit from income splitting
• You have concerns about a beneficiary's financial management, marriage stability, or potential creditor issues
• Your estate is worth more than $500,000

Testamentary trusts vs family trusts

A family (inter vivos) trust is set up during your lifetime. A testamentary trust is set up through your will and only activates on death. The critical difference for tax purposes is the minor income splitting advantage — family trusts do not get this treatment, but testamentary trusts do. This is the primary reason testamentary trusts can be more tax-effective than simply transferring assets into an existing family trust.

Do testamentary trusts attract stamp duty or capital gains tax on establishment?

In most Australian states, transferring assets into a testamentary trust on death does not attract stamp duty (the main residence exemption and deceased estate exemptions apply). Capital gains tax consequences depend on the nature of the asset — main residence assets are generally CGT-exempt, while investment assets receive a cost base reset to date-of-death value.

How are testamentary trusts structured?

A testamentary trust will typically names: a primary trustee (often the surviving spouse or an adult child), a class of beneficiaries (the spouse, children, grandchildren, and their spouses), provisions for who succeeds as trustee, and the extent of the trustee's discretion. Multiple testamentary trusts can be created in a single will — for example, a separate trust for each child's family.

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Testamentary trusts are one of the most effective but underused tools in Australian estate planning. At JJ162 Chartered Accountants, we work alongside estate planning solicitors to help clients structure their affairs so their wealth is preserved and transferred as efficiently as possible.