Testamentary trusts – an overview

A testamentary trust is an effective estate planning tool that can provide greater flexibility when it comes to protecting assets and minimising tax when distributing assets to beneficiaries.

Testamentary trusts are established through an individual’s Will that do not come into effect until the individual has passed away.  The trust outlines a structure whereby assets are managed by appointed trustees for the benefits of the beneficiaries nominated in the Will.

There are two types of testamentary trusts with the first being a discretionary testamentary trust.  Beneficiaries are provided with the option to take part of all of their inheritance via the testamentary trust.  The primary beneficiary can remove and appoint the trustee and can appoint themselves to manage their inheritance inside the trust.

The second type is a protective testamentary trust.  This trust requires the beneficiary to take their inheritance via the trust without the option to appoint or remove trustees.  This may be useful when a beneficiary is not able to manage their inheritance due to age, disability or spending tendencies.

The main benefits of a testamentary trust are the taxation advantages it creates for beneficiaries receiving income earned from the inheritance and its ability to protect assets.

When a beneficiary accepts their inheritance in their personal name, they are required to pay income tax at their personal marginal tax rate.  A discretionary trust can provide significant tax advantages, especially when the beneficiary has a high marginal tax rate, a partner on a lower income and minor children/grandchildren.

Assets are protected in a testamentary trust since they cannot be taken out of the trust without the trustee’s discretion to distribute the benefit to beneficiaries.  Beneficiaries do not legally own the assets which protects them from creditors, waste and dissipation by the beneficiary or claims on the beneficiary’s assets in circumstances such as divorce or bankruptcy.