What is a Testamentary Trust and what are the advantages of having one in your Will?

What is a Testamentary Trust?

A testamentary trust is a discretionary trust set up by a Will.  There are many different reasons for adopting a testamentary trust:  tax advantages of splitting income, protection in family court matters, protection from bankruptcy and protection for disabled or beneficiaries with illnesses.

Without a testamentary trust, a beneficiary receives their inheritance directly.  Under a testamentary trust, the assets are transferred to the trustee of the testamentary trust and held on trust for and on behalf of the beneficiary.  The trustee controls the assets and has the discretion to distribute all or part of the assets to the beneficiary.

What are the advantage of having a Testamentary Trust?

1.      Tax Advantages

The discretionary power to split income allows the trustee to distribute income to none or any one or more beneficiaries without being bound to proportionality or equality.  The discretion allows the trustee to take advantage of favourable tax rates, particularly for minor beneficiaries because where distributions are made to a minor, any amounts up to the adult tax-free threshold (which is currently $18,200) is completely tax free.  Therefore, making distributions to minors from a testamentary trust can have the potential for significant tax savings.

2.      Protection in Family Court Matters

The deceased may have a child involved in family court matters and therefore one way to provide asset protection to that child (beneficiary) is to transfer their entitlement to a testamentary trust.  Under the terms of that trust, ensure that the child beneficiary has no control over the income or capital of the trust.  Instead, control should be with the trustee.  This shall assist in the child’s argument that assets in the testamentary trust are excluded from the matrimonial pool and prevent a claim of those assets by the separated spouse.

3.      Protection from Bankruptcy

If a beneficiary becomes entitled to an inheritance while they are bankrupt, that beneficiary's inheritance is classified as being 'after acquired property' and will vest in their bankruptcy trustee and be divided between their creditors.   If the assets are transferred to a testamentary trust those assets can be protected from external creditors and the bankruptcy trustee because the assets are not owned by the bankrupt beneficiary.

4.      Protection for beneficiaries with illnesses or disabilities

Intellectually disabled beneficiaries and those with illnesses or addiction problems can benefit from a testamentary trust because their assets can be managed within the trust for the benefit of that beneficiary as opposed to having a government agency involved (for the disabled beneficiary) or risk the dissipation of an inheritance by a beneficiary with addiction problems.

In our next article we will discuss the disadvantages of having a Testamentary Trust.