What is a testamentary trust, and do I actually need one?

What it actually is, in one paragraph

Your will creates the trust and names a trustee — very often the adult beneficiary themselves — plus a class of people who can receive from it: usually that person, their spouse, their children and related entities. Nothing exists while you are alive. There is no separate document to maintain, nothing to lodge, no annual cost. The clause sits dormant in your will, possibly for decades.

On your death, the executor administers the estate and transfers that beneficiary's share into the trust instead of into their bank account. From then on the trustee decides, year by year, who receives income and capital from within that family class. That discretion is where the whole benefit comes from — both the tax saving and the protection.

The useful mental image: an ordinary will hands your daughter a cheque. A testamentary trust hands her a box with her name on it. She usually holds the key. But the money inside the box is not legally hers, and that one distinction is what does all the work.

How a testamentary trust works

Your will sets up the trust and names the trustee — very often the adult beneficiary themselves — and the class of beneficiaries, typically that person, their spouse, their children and related entities. Nothing happens while you are alive. On your death, the executor administers the estate and transfers the relevant assets into the trust rather than to the beneficiary personally.

From then on the trustee decides each year who receives income and capital from within the beneficiary class. That discretion is where both the tax advantage and the asset protection come from.

The tax advantage — the excepted trust income rule

Income distributed to a minor from an ordinary family trust is taxed at penalty rates that begin at a few hundred dollars. Income distributed to a minor from a testamentary trust is 'excepted trust income' and is taxed at ordinary adult marginal rates, which means it attracts the full tax-free threshold.

Put a number on it. Your son inherits $800,000 and it earns, say, 5 per cent — $40,000 a year. Paid to him outright, that income sits on top of his salary and is taxed at his top rate. Held in a testamentary trust with three young children in the beneficiary class, a slice can be distributed to each child and taxed as if they were adults, tax-free threshold and all. The school fees start getting paid out of income the tax office never touched. That is the single most common reason a testamentary trust is worth setting up.

Integrity rules introduced in 2019 confine the concession to income from assets that came from the estate — you cannot inject unrelated assets into the trust to soak up the benefit. The trust must be properly administered and the estate assets identifiable.

Asset protection — the reason most clients ask

Assets held in a testamentary trust are not owned by the beneficiary personally. That matters in three situations that come up constantly:

• Relationship breakdown — trust assets are not automatically property of the marriage, though the Family Court can still treat a trust the beneficiary controls as a financial resource or, in some cases, as property; control and history of distributions matter
• Bankruptcy — an inheritance received outright vests in the trustee in bankruptcy; assets in a properly structured trust generally do not, which is why the structure matters for beneficiaries in business or professional practice
• Vulnerability — a beneficiary with an addiction, a disability, an intellectual impairment or simply no financial judgement can be provided for without ever holding the capital, with an independent trustee making the decisions

The case for

Stripped of the jargon, there are five honest arguments in favour:

• Tax. Grandchildren under 18 can receive trust income at adult rates with a full tax-free threshold each — the benefit repeats every year the trust runs.
• Divorce. Money paid into a child's joint account is in the matrimonial pool the day it lands. Money in a properly structured discretionary trust is considerably harder to reach.
• Creditors. Builders, directors, doctors, anyone carrying guarantees or negligence exposure — an inheritance in their own name is exposed; a trust interest is not owned the same way.
• Protecting someone from themselves, or from other people. Addiction, disability, a persuasive new partner. The trust provides for them without ever putting capital in their hands.
• Keeping capital in the bloodline. Blended families especially: provide for your spouse for life, with what is left passing to your own children rather than to their next relationship.

The case against

The arguments against are less glamorous and more often ignored, so here they are without the varnish:

• It costs money every single year. Its own tax file number, annual financial statements, a tax return and distribution resolutions signed before 30 June. Accounting fees, forever, for as long as the trust runs.
• Someone has to actually do it. A trust administered badly is worse than no trust — miss the resolutions and the tax concession you built the thing for can be lost.
• Beneficiaries can find it insulting. 'Dad didn't trust me' is a real conversation, and it is worth having with them while you are alive rather than leaving it in a document.
• The tax benefit needs income to work on. On an estate of a modest home and some super that will clear a mortgage within a year, there is no income to stream and nothing to save.
• It is not a force field. It does not stop a family provision claim against your estate, and the Family Court can look straight through a trust the beneficiary plainly controls.

So do I need one? A short self-test

Run your own situation past these. One clear yes usually justifies at least a conversation; three or more and you would want a good reason not to.

• Will the estate be big enough to stay invested and produce real income, rather than being spent within a year or two?
• Does a beneficiary have children under 18, or likely to have them?
• Is a beneficiary in business, a company director, or in a profession that gets sued?
• Is a beneficiary's marriage or relationship shaky?
• Does a beneficiary have a disability, an addiction, or a settled history of poor money decisions?
• Is this a blended family where you want a spouse looked after for life but the capital to reach your own children?
• Will there be someone in the family organised enough to keep the trust properly administered?

When it is not worth it

A modest estate that will be spent within a year or two on a mortgage does not justify a trust. Neither does a plan where every beneficiary is a financially settled adult with no children, no exposure and no intention of leaving the money invested.

Be honest about the running costs. Each trust needs its own tax file number, an annual tax return, financial statements and annual distribution resolutions before 30 June. Budget for accounting fees every year for as long as the trust runs. If nobody in the family will keep up with the resolutions, the structure will be administered badly and the concessions can be lost.

We will tell you when the answer is no. A straightforward will, properly drafted, is the right outcome for plenty of Queensland families and there is no fee in hearing that.

Optional or mandatory?

Most well-drafted Queensland wills make the testamentary trust optional. The beneficiary is given a period after death — often within a set number of months — to elect whether to take their share outright or through the trust, with the trust as the default.

That flexibility is valuable, because circumstances at your death may be nothing like circumstances today. Mandatory trusts are reserved for situations where the very point is to keep control away from the beneficiary — vulnerability, addiction, or a blended family where the capital must pass on.

Choosing the trustee and drafting the controls

Where the purpose is tax and asset protection, the beneficiary is usually their own trustee — they control their inheritance while holding it in a protective structure. Where the purpose is to protect a beneficiary from themselves, the trustee must be someone else, with a mechanism for replacing them and a clear line of succession.

• Name the appointor — the person who can hire and fire the trustee; this is where real control sits
• Define the beneficiary class carefully: too narrow defeats the tax planning, too broad creates duty and family provision arguments
• Deal with succession on the beneficiary's death — does the trust continue for their children, or vest?
• Set the vesting date; Queensland's rule against perpetuities limits the maximum term
• Address who pays the trust's costs, and whether the trustee may borrow, invest in business or hold the family home

How it fits with the rest of your estate plan

Superannuation and life insurance often make up the bulk of an estate and do not automatically pass under your will. Directing super to the estate through a binding death benefit nomination so it can flow into the trust needs care — the tax treatment for adult, non-dependent children differs sharply.

Assets held in a family trust or a company are not yours to give in your will either; what passes is control. A testamentary trust is one part of a plan that also has to deal with super, jointly held property, business succession and your enduring power of attorney.

Testamentary trust questions we are asked in Queensland