What is a testamentary trust?
A testamentary trust is a trust created in a Will which deals with assets from the estate by providing that they be held by a trustee for the benefit of beneficiaries. The trust takes effect upon the testator’s death.
How does it work?
A common form of a testamentary trust is where cash or other assets are directed to be held by a trustee, usually the executor of the will, for the benefit of family members such as children, grandchildren, a spouse or some other relative.
The trustee has the responsibility and power in determining how and when the assets are distributed. Sometimes the testator may provide directions about how it is to be done in the will.
Wills involving gifts to minor children will create a testamentary trust where the items are held on trust by the executor until the child attains the age of 18 or later age specified.
Another example of a testamentary trust is where an asset is given to one person (the trustee) to hold for another person (the beneficiary) for their lifetime. It is then passed to a third person after the death of the beneficiary.
This type of testamentary trust is often used in respect of real property, for instance where an older beneficiary has left the use of a house for their lifetime before it passes to younger beneficiaries.
Should I be thinking about a testamentary trust for my estate?
A Testamentary trust is useful in the following scenarios:
- You want to specifically provide for the education and welfare of children or grandchildren.
- You wish to leave a gift to a beneficiary with special needs or who suffers from some intellectual incapacity and needs somebody to look after the gift for them.
- You have a substantial estate and want to distribute it in a more tax-effective way.
- You want to leave assets to a person who has a substance or gambling addiction or a tendency for overspending and it would be prudent to have someone else manage the assets.
- You want to provide asset protection in the case of the separation and divorce of your child or children from their spouse.
What are the advantages of a testamentary trust?
One of the major advantages of testamentary trusts is more favourable taxation treatment for income distributed to children.
Children receiving income from a testamentary trust can take advantage of the normal adult tax-free threshold ($18,200) and marginal tax rates. This treatment is more favourable than that of distributions from a family trust which does not receive the benefit of the threshold or sliding scale of the adult marginal tax brackets.
An example of how this might be beneficial is where you might want to leave your estate to an adult child who has 2 school-age children of their own. Assuming the adult child was paying tax at the top marginal tax rate, if a testamentary trust is established and income distributed to the children for their schooling and maintenance of say $20,000 per annum each that income would be effectively tax-free for the children as opposed to being taxed at the top marginal tax rate in the hands of the adult child if no trust was established.
Testamentary trusts can also be used to provide asset protection from assets being lost to divorcing spouses of children or beneficiaries with drug, gambling or spending problems.
What are the disadvantages of a testamentary trust?
Testamentary trusts involve work and administration which costs time and money. Tax returns have to be filed by the trustee each year and accounts need to be kept.
The cost of a will with testamentary trusts will be higher than a normal will in a straightforward estate.