Testamentary trusts: what they are and when to use one

Most wills give assets to beneficiaries directly. A testamentary trust does something more sophisticated, holding what you leave in a trust for your beneficiaries rather than handing it over outright. For the right family, the benefits are significant. This guide explains what a testamentary trust is and when it is worth considering.

What a testamentary trust is

A testamentary trust is a trust created by your will that comes into existence when you die. Instead of a gift passing directly to a beneficiary, it passes into a trust, where a trustee holds and manages it for the benefit of the beneficiaries you nominate.

It sits inside your will, so it costs nothing while you are alive and only springs into life on your death. The beneficiary you want to provide for becomes a beneficiary of the trust, and often controls it, rather than receiving a lump sum directly. That single change, holding the inheritance in trust rather than giving it outright, is what unlocks the benefits below.

Asset protection

The first major benefit is asset protection. Because the inheritance is held in a trust rather than owned directly by the beneficiary, it can be better protected in several situations.

If a beneficiary faces a relationship breakdown, assets held in a properly structured testamentary trust may be treated differently from assets they own personally, though family law outcomes are never guaranteed. If a beneficiary is in business or a profession and faces creditors or a claim, assets in the trust can be harder to reach than assets in their own name. And if a beneficiary is vulnerable, through disability, addiction, or simply being young, a trust lets someone responsible manage the inheritance for them rather than handing a large sum to someone who cannot manage it.

For parents, this last point often matters most. A testamentary trust means you are not forced to choose between giving a child nothing and giving them a lump sum they are not ready for.

Tax advantages

The second major benefit is tax. Income earned on the assets in a testamentary trust can be distributed among beneficiaries, and income distributed to minor children from a testamentary trust is generally taxed at adult marginal rates rather than the penalty rates that usually apply to minors. For a family with children, that can be a meaningful, lasting advantage.

As always with tax, the detail matters and the rules can change, so the tax side should be confirmed with your accountant. But the broad point holds. A testamentary trust can make an inheritance work harder, across a family, for years.

The flexibility to tailor

A testamentary trust can be shaped to the family. It can be optional, so the beneficiary chooses whether to use it. It can concentrate control in the beneficiary themselves, or place it with an independent trustee where that is safer. It can last for the life of the trust, giving long-term protection, or be wound up when it is no longer needed. This flexibility is why testamentary trusts are a standard tool in more sophisticated estate planning.

When a testamentary trust is worth it

A testamentary trust is not for everyone. It adds complexity and ongoing administration, including annual accounting and tax, and for a modest estate with straightforward beneficiaries it can be more than is needed.

In our experience, a testamentary trust earns its place where there is a reasonable amount of wealth to pass on, where there are children, especially young children, where a beneficiary is vulnerable or exposed to relationship or creditor risk, or where the family wants the tax and protection benefits to continue beyond the moment of inheritance. The way we frame it for clients is simple. The more there is to protect, and the more vulnerable or exposed the people you are providing for, the more a testamentary trust is worth considering.

How we help

We advise on whether a testamentary trust suits your family, and build it into your will so it does what you want, with the right control and the right protections. We work with your accountant on the tax side, so the structure and the tax position line up. Estate planning is not just about who gets what, it is about how they get it, and a testamentary trust is one of the most useful tools for getting that right.

Frequently asked questions

What is a testamentary trust? A trust created by your will that comes into existence when you die, holding a beneficiary's inheritance in trust rather than giving it to them outright.

What are the main benefits? Asset protection, including in relationship breakdowns and against creditors, protection for vulnerable or young beneficiaries, and tax advantages, especially for income distributed to children.

Is a testamentary trust worth it for a small estate? Often not. It adds complexity and ongoing cost, so it best suits families with meaningful wealth, children, or beneficiaries who are vulnerable or exposed to risk.

Does a testamentary trust save tax? It can, including taxing income distributed to minors at adult marginal rates rather than penalty rates. Confirm the detail with your accountant.

Keep reading

• Wills and estates
• How to make a valid will in NSW
• What is a family trust and how does it protect assets?

This article contains general information only and is not legal advice. For advice about your situation, please contact us. Liability limited by a scheme approved under Professional Standards Legislation.