A Testamentary Discretionary Trust is a discretionary trust set up within a Will. ‘Discretionary’ means that the person or entity with daily control of the Trust (the ‘Trustee’) has the discretion as to how a Trust’s income and assets are distributed amongst the Trust beneficiaries.

Discretionary Trusts often have a wide range of beneficiaries, principally family members of the person/s nominated as the Primary Beneficiary/ies. Hence the terms ‘Family Trust’ and ‘Discretionary Trust’ are often interchangeable.

In a testamentary discretionary trust, the primary beneficiary is usually the Will maker’s spouse or child/ren.

A testamentary discretionary trust is usually set up for the benefit of the primary beneficiary and his or her family. It may be controlled by the Primary Beneficiary and/or people who are trusted to act in the Primary Beneficiary’s best interests.

Can a Will contain more than one testamentary discretionary trust?

Yes. Will makers often create a separate Testamentary Discretionary Trust for each of their children.

What are the advantages of a testamentary discretionary trust?

Flexibility

The share of an estate which passes to a testamentary discretionary trust may be divided amongst a range of potential beneficiaries, so there is huge flexibility as to the potential distribution of capital and income.

Possible Taxation Benefits

While we cannot give financial or taxation advice, we understand that accountants and financial planners often advise clients that a Testamentary Discretionary Trust may have some taxation benefits. These include:

1.       Flexibility in Distribution of Income.

The ability to distribute income amongst a number of beneficiaries. If some recipients of income are in lower tax bracket than the primary beneficiary, less tax may be paid on distributions made to those in lower tax brackets

2.       Tax Free Thresholds

Children under 18 are usually entitled to only a very small amount from family and discretionary trust distributions. In ordinary discretionary trusts (i.e. those not created under a Will), only $416 per year may be distributed to children, tax free.

With testamentary discretionary trusts, the adult tax free threshold (currently $18,200) applies to children under 18, so each child can receive benefits up to the amount of the full tax free threshold before tax applies to these distributions (assuming they have no other income). A child who is a potential beneficiary of a testamentary discretionary trust may receive up to $18,200 before tax becomes payable. Those with a number of children might distribute a significant amount of income before income tax would be payable.

Asset Protection

Creditors

Rather than passing an inheritance directly to a beneficiary, it is placed in a Trust which is usually for the benefit of that beneficiary and his/her family. If that beneficiary encounters financial difficulties in future, the assets held within a testamentary discretionary trust may not be available to their creditors. Even if the beneficiary becomes bankrupt, the assets may be preserved.

Potential Family Law Benefits

If a person who is a beneficiary of a testamentary discretionary trust is embroiled in Federal Circuit and Family Court (the Court) proceedings, the Trust assets may remain intact and not be included in the pool of assets from which a distribution to a beneficiary’s ex-spouse is drawn. Whether or not the Court is able to deal with the assets of the testamentary discretionary trust is determined by who ultimately controls it. If the testamentary discretionary trust is controlled by the person involved in the Court proceedings, the Court will likely be able to deal with those assets. In that event, that person may receive credit for contributing the testamentary discretionary trust assets to the pool of assets to be distributed between the parties.

Takeaway

Testamentary discretionary trusts give greater flexibility to the distribution of an estate and income on inheritances, with some potential long-term asset protection benefits.

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