Put simply, the term ‘Testamentary Trust’ or ‘Testamentary Trust Fund’ refers to provisions which are included in a Will to establish one or more separate trust funds for the benefit of each of the intended beneficiaries of the willmaker’s estate.
Under the Will, either specific assets of the deceased willmaker, or specified proportions of the willmaker’s distributable estate (residuary estate) are allocated to individual Testamentary Trust Funds for the benefit of the intended beneficiary, commonly called a Principal Beneficiary. Usually, each child of the Willmaker will be a Principal Beneficiary under the Will, with his/her own separate Testamentary Trust Fund.
Each separate Testamentary Trust is a discretionary trust which operates in a manner similar to the operation of family trusts often established by individuals during their lifetimes (Inter Vivos Trusts).
The essential feature of a discretionary trust (whether a Testamentary Trust or an Inter Vivos Trust) is that instead of assets being held by the estate trustees on trust for a single beneficiary, those assets are held on trust for a broadly-defined class of beneficiaries. In the case of each Testamentary Trust established under a Will, the class is defined by reference to the relevant Principal Beneficiary.
The assets of the Testamentary Trust are the assets of the estate which the willmaker intends to pass for the benefit of that Principal Beneficiary. The class of beneficiaries includes the Principal Beneficiary personally, his/her relatives (broadly defined to include spouse, children, grandchildren and more distant relatives and their spouses) plus a range of wider potential beneficiaries (including trusts and companies in which the Principal Beneficiary has a direct or indirect interest).
When making a distribution of income or capital, the trustee(s) of a discretionary trust have an obligation to consider the entire class of beneficiaries, but an absolute and final discretion regarding in whose favour and in what proportions that decision is ultimately exercised. That discretion can be exercised in favour of one beneficiary or a number of beneficiaries. If appropriately drafted, the trustee can exercise that discretion in favour of himself/herself.
The original trustees of each Testamentary Trust are the trustees of the willmaker’s estate. However, if a Principal Beneficiary becomes the trustee of his/her Testamentary Trust (see below), that Principal Beneficiary controls the distributions of income and capital at all times and can distribute income or capital to any one or more beneficiaries (including himself/herself solely) as a matter of absolute discretion.
Why have testamentary trusts?
There are a number of benefits resulting from the establishment of Testamentary Trusts under a Will. One reason for their current popularity is concessional taxation treatment of income or capital gains distributed to children from a trust established pursuant to a Will.
Unlike similar distributions from inter vivos trusts, children under the age of 18 who receive a distribution of income or capital gains from a Testamentary Trust are not subject to the high ‘unearned income’ marginal rate of tax on those distributions (currently 45 per cent) or restricted to a limited ‘tax free’ threshold (currently $1,333). Under a Testamentary Trust, children under the age of 18 are instead taxed at the normal (progressive) individual marginal rates of tax and are also entitled to the normal ‘tax free’ threshold (currently $10,000). A Testamentary Trust which delivers income to children or grandchildren of the willmaker, therefore, can provide substantial benefits for funding education and other requirements during the minority years of the children concerned.