TESTAMENTARY TRUSTS


This follows on from an article about superannuation and Wills.
It is designed to be read in conjunction with that article where the Testator (Will maker) wants to limit the ability of beneficiaries to access the estate assets but it’s equally relevant if the estate assets do not include superannuation benefits. The normal method of limiting the ability of beneficiaries to access assets is by creating a life interest, a protective trust or a testamentary trust.

What is a life interest?

This is where the assets are invested and person A gets the income during his life and on his death the capital goes to person B. Variations on this theme are possible. E.g. the TESTAMENTARY TRUSTS interest may be for a period of years rather than for someone’s life or it may be for a period terminable at the discretion of the trustee.

There may be a full or limited right of access to the capital.

The advantage of this scheme is that person A has no right (or a limited right) to capital. The disadvantages are that if person A is proposed to be the real beneficiary he will not have control over the assets and may have very restricted rights to capital.

What is a protective trust?

This is a trust which is governed by section 39 of the Trustee Act. It is a form of life interest but is terminable if the beneficiary does anything which would deprive him of the right to receive the income e.g. if he became bankrupt or assigned his rights. On termination of the beneficiary’s rights the income is distributable between the beneficiary his spouse and children or, if there is no spouse or children, the persons who would be entitled to the beneficiary’s estate if he were dead. This form of trust is rarely used because it doesn’t have any advantages over a testamentary trust and certainly does not have the advantages of a testamentary trust.

What is a testamentary trust?

In strict terms it is any trust created by Will but the expression is normally used to indicate a discretionary trust created by Will. A discretionary trust is one where the Trustees have a discretion as to who among a defined range of beneficiaries gets the income and/or the capital. In this article reference to testamentary trusts is to discretionary testamentary trusts.

What are the advantages of testamentary trusts?

- Assets of a discretionary trust should be immune from claims by creditors and by spouses or domestic partners.

The reason is that a beneficiary merely has a right to be considered by the Trustee – he has no right to income or assets unless and until the Trustee exercises his discretion in favour of the beneficiary. If a beneficiary has no claim on or ownership of trust assets it follows that neither a creditor nor a partner can have a claim on those assets.

- It is possible to exercise control over the future use or disposition of trust assets. An allied advantage is flexibility in the distribution of income and/or capital.

- There may be income tax benefits. If there are infant children income distributed to them will be taxed at normal adult marginal rates.

What are the disadvantages of testamentary trusts?

- If the aim is to safeguard assets against claims by creditors/partners/spouses there will be necessarily some tradeoff between achieving this aim while at the same time allowing the real beneficiary to retain control.

- There will be record keeping and it will be necessary to furnish trust income tax returns annually (in addition to personal income tax returns). It is probably correct to say that the structure of a testamentary trust may be cumbersome and expensive.

- There are quite onerous responsibilities on trustees in the administration of the trust assets. Trustees who are not beneficiaries may be reluctant to accept trusteeship.

- The creation of the testamentary trust is more expensive than a standard Will.

- If the trust holds land then land tax may be assessed at the trust surcharge rates after 3 years from the death of the testator (it is possible to apply to extend this 3 year period).

- As with all trusts there is the risk that an inappropriately chosen trustee will not act as envisaged and may not act even handedly.

Should you have a testamentary trust?

The answer is yes but only if there is a particular problem which a testamentary trust may overcome or assist. A distinguished Victorian commentator on testamentary matters said sometime ago of testamentary trusts “it is something which many people seem to think they want, something for which people are prepared to pay and something which is likely to be of real benefit to the families of only a small proportion (of people)”.

What is the structure of a typical testamentary trust?

To quote from Boaden’s Wills Probate and Administration Service (Vic) one popular structure gives the estate to the spouse of the Will maker, and in the event of the spouse predeceasing, sets up a separate trust for each of the children of the testator, the appointor of each (trust) is the child and the objects (beneficiaries) of each (trust) are the child, spouse, grandchildren, siblings and so on. This gives the child of the deceased testator effective control over that portion of the estate, with the flexibility that discretionary trusts bring. A separate discretionary trust could be set up for the spouse of the testator in a younger family. The same considerations apply. The terms of the trust in the Will usually provide that the Trustee has an absolute discretion to make distributions to anyone or all of the objects (beneficiaries) of the trust. This power lasts for 75 or 80 years, 80 years being the maximum duration allowed at the end of which the capital of the trust will be distributed to the such beneficiaries as the trustee determines. The terms may allow either income or capital both to be advanced to the objects (beneficiaries) during the life of the trust and may allow the primary beneficiaries to take the capital of the trust early. The strength of such trust arrangements lies in their flexibility. The power of a beneficiary to exclude him or herself in the trust, the power to advance capital and the power to bring trust to an end or create flexibility so that the trust may be dismantled if family circumstances or legislative change make it appropriate.

Who should be trustees?

The answer will depend on the purpose for which the testamentary trust is established. If the aim is to access tax benefits or to control the distribution of income/capital in a family the principal beneficiary could be the Trustee. If the aim is to protect a spendthrift child that child should not be the Trustee – the Trustee should be a responsible person who has the interest of the spendthrift child at heart and who has the expertise to manage the trust. A professional Trustee should perhaps be considered. If the aim is to guard against claims by creditors or spouses/partners the main person for whose benefit the trust is established should not be the sole Trustee – if the aim is to say that the assets in a trust do not belong to a particular person i.e. that he is just a beneficiary whose interests are to be considered by the Trustee then you cannot very well have the main beneficiary as the sole Trustee. A solution may be to appoint the main beneficiary and another family member. As Boaden’s Wills Probate and Administration Service says of the choice of Trustee “this may be a vexed question indeed”.

What does the Appointor do and who should be the Appointor?

The Appointor has power to remove a Trustee and appoint a substitute or additional Trustee. His position is most important – if you can dictate who is to be the Trustee you can control the trust.

If the reason for the creation of the testamentary trust is to protect against a spendthrift child it clearly makes no sense for him to be the Appointor. If the reason for the creation of the testamentary trust is to protect against claims by creditors or by spouses/partners there is good reason not to have the main beneficiary as sole appointor because

- a Trustee in bankruptcy might seek to exercise the Appointor’s power and appoints a Trustee who would direct trust assets to the main beneficiary and thus make the trust assets available to creditors. (To date the Appointor’s power has not been available for exercise by a Trustee in bankruptcy but this might change in the future).


- If the main beneficiary was Appointor and was involved in a family law property dispute the Family Court may be able to direct that the power of appointment be exercised in a particular fashion and that might result in assets becoming subject to the directions of the Family Court.

As with the choice of Trustees the choice of Appointors may be a vexed question.

How long does the trust last?

It can last for up to 80 years but there will normally be a right for the Trustees to terminate it earlier.

What happens to the income and assets of the trust during its operation and when it ends?

During the operation of the trust the Trustees will allocate the income between the beneficiaries as the trustees see appropriate. The trustees will also have power to allocate capital.

When the trust comes to an end the capital will be allocated as provided in the trust deed. This may be

- to persons nominated by the trustee (and that nomination may be made well before the distribution is made).

- to persons nominated in the trust deed.

- the persons who benefit under the main beneficiaries Will.