Are Testamentary Discretionary Trusts dead? - Definitely Not!

5 June

As you may be aware there are potential changes on foot in relation to Testamentary Discretionary Trusts and tax.

There’s been a lot of media commentary about the benefits of trusts (including TTs) after the Federal budget announcements, and understandably, you may be wondering whether TTs are still worthwhile.

I’m reaching out to clear things up and put your mind at ease.

So, are testamentary trusts dead after the budget? (pardon the pun)

Definitely not.

They are as powerful as ever when it comes to estate planning.

There are so many benefits of using a TT over a basic will, and only one of those benefits (under the current rules) is tax planning.

Here's what we know

TTs already in existence where the willmaker has died have been given protected status and shouldn’t be impacted by the changes.

Income earned by new TTs will be taxed at a minimum 30% tax rate when distributed to adults. For anyone already earning over 45% of other income (e.g. from salary and wages, personally held investment income etc), the tax treatment under the new proposed rules will be effectively the same as it is now.

TTs will still offer the flexibility each year to choose which of the beneficiaries will and won’t benefit from the trust, and the trustee will still be able to ‘stream’ income amongst multiple beneficiaries for tax planning.

TTs still offer incredible asset protection for family law, vulnerable beneficiaries, protecting minor children from financial immaturity, and people in high risk occupations or business.

For beneficiaries who are not currently earning $45,000 of income each year from other sources and where the only income they earn is from a TT (think retirees, adult children at university who aren’t working) – they will be paying a higher rate of tax under the proposed arrangements than under the current arrangements.

If you want to access the benefits of a TT (which we’ll discuss in more detail below) – it needs to be in your will before you die. It’s too late to set up one after you’ve died

When we prepare your wills with TTs, we know that the tax and legal landscape around them can change. We do our best to give you the most accurate information at the time of making your will, but we also strategically factor in lots of flexibility.

The TTs that we draft are optional, which means your loved ones and executor can get specific legal, tax and financial advice at the time of your death to evaluate what the state of the law is, and decide on the most advantageous approach factoring in all the circumstances at the time. If they decide that the TTs are the right structure, then they’re protected. If it turns out that they no longer need the benefits of the TTs, then they’re not locked in. It’s the best of both worlds.

Here’s what we don’t know yet

The new proposed tax arrangements for discretionary trusts are not law; they’re simply a government announcement. The new tax rules are intended to come into effect for 1 July 2028 (over 2 years away) but who knows what will happen by then? There’s a lot that needs to happen with industry feedback and actually drafting and enacting the legislation (in fact, we’ve been here before around 20 years ago under the Ralph Review and the changes were ultimately abandoned because the process became too hard).
We don’t know how allocating income from TTs to minors will be treated. Under the current tax rules, TTs have special status – historically the government has recognised that someone has had to die in order for the TT to exist, which means that they have allowed tax free amounts of around $22,000 per child per year to be released from the TT.
Right now, we do not know if this will continue. The budget papers indicate that income to “vulnerable minor” beneficiaries from trusts will be exempt from the new rules, but we don’t have clarity on whether that means they will protect the existing arrangements, make new arrangements, or narrow the eligibility.

If they do respect the existing arrangements for income to minors, then this will make TTs an even more attractive tax structure compared to companies and family trusts.

The benefits of using a TT in your will

We know it can be difficult to make a decision when there is so much uncertainty in play.

But it’s important to remember there are many benefits of TTs that are not impacted by the tax treatment.

Here’s a refresher of how a TT can super charge your legacy goals compared to a basic will:

If you have young children

If you’re in a couple and only one of you dies: The TT lets your surviving spouse re-partner, move on with their life (after a suitable mourning period of course!) but the inheritance you left for your kids is protected. Your spouse’s new will is irrelevant because you are setting up the succession plan for your inheritance under your will. Your spouse can enter into new relationships, have more children etc. but they won’t be entitled to the inheritance you left for your kids. Without a TT, you are relying solely on your spouse’s new will and for them to do the right thing by your kids together.
If you’re in a couple and only one of you dies: The TT increases the protection of the inheritance you left for your kids even if your surviving spouse enters into a relationship breakdown and goes through a family law property settlement. Rather than the inheritance being automatically included in the property settlement pool, the starting point is that it is excluded. You can never say never when it comes to family law…but you give your kids a fighting chance with a TT compared to a basic will.
If you’re in a couple and only one of you dies: If the survivor of you is at risk of being sued e.g. you’re in a high-risk profession, running a business – the inheritance is protected from those claims and preserved for your kids
If you both die together: We’ve all heard stories of 18 year olds blowing through their inheritance on frivolous spending. This is a big risk with a basic will. A TT lets you choose what age your kids get financial control over their inheritance and you can push it out to whatever age you think appropriate (e.g. 25, 30…) and leave people that you trust in charge of managing the inheritance until your kids are ready.

If you have adult children

Leaving your inheritance to your children through a TT increases the protection of the inheritance, especially if your child enters into a relationship breakdown and goes through a family law property settlement. Rather than the inheritance being automatically included in the property settlement pool and potentially ending up in the hands of in-laws, the starting point is that it is excluded. You can never say never when it comes to family law… but you give your kids a fighting chance with a TT compared to a basic will.
If any of your children are at risk of being sued because they’re in a high-risk profession or running a business etc, the inheritance is protected from those claims so it can stay in your family.
A TT lets you ‘rule from the grave’ to protect your grandchildren. If you make a basic will and leave the inheritance directly to your children, you are then relying on your children to make wills to pass what’s left of your inheritance down to your grandchildren. With a TT, your child’s will is irrelevant because you are setting up the succession plan for your inheritance under your will. If this is important to you, we can take steps now to set in motion what happens to the inheritance after your child dies.
If the worst happens and one of your children dies before you, leaving young children of their own, then using a TT protects those grandchildren from wasting their inheritance on frivolous spending as soon as they turn 18. This is a big risk with a basic will. A TT lets you choose what age your grandchildren get financial control over their inheritance and leave people that you trust in charge of managing the inheritance until they are ready
We appreciate this is a lot of information to digest and well done for reading this far!

As you can see, the tax treatment is only one small part of a comprehensive estate planning strategy involving TTs.

If you have any questions or concerns and want to chat about how these recent announcements impact you and your family, please reach out.

You can Book your FREE CHAT via this link.