Should my will include a Testamentary Discretionary Trust?

A testamentary discretionary trust (TDT) is a special type of trust created within your will.

The TDT is different from a typical simple will.  In a typical simple will the bequests or gifts of the will are given directly to the beneficiaries (subject to any delay until the age set out in the will if the beneficiaries are minors). That means the beneficiary receives the gifted asset in full. For example a bequest of $500,000.00 is transferred into the beneficiaries bank account. If the beneficiary invests that money and earns interest she will pay tax on that income at her marginal tax rate.

Under a TDT the gifted assets are transferred to the trustee of the TDT to be held under the terms of the TDT. Those terms will generally include that the trustee has a discretion as to how to distribute the capital and income of the trust.

Just as an aside, a trust can generally be described as an ownership structure where an individual or company (the trustee) holds the trust property for the benefit of others, (which can but doesn’t necessarily include the trustee), (the beneficiaries).

The discretion afforded to the trustee in distribution of the assets and income of the trust can provide advantages a typical simple will cannot. This advantages include:

  • Distribution trust income to beneficiaries on lower marginal rates of income (tax advantages);
  • Protection from bankruptcy; and
  • Protection from family law.

The TDT allows for the taxable income generated by the trust to be allocated to the beneficiaries in a tax-effective manner. Under a standard will, a beneficiary takes their inheritance in their own name and they will pay tax on the income and capital generated from the assets at their personal marginal rate. The tax paid on the assets can be quite significant if you are already earning a considerable income. Under a TDT however, beneficiaries under the age of 18 years are taxed at normal adult tax rates**. This is an advantage as income and capital generated from the assets in a TDT can be allocated to children or grandchildren. Using normal adult tax rates through allocation to children and grandchildren takes advantage of the tax free threshold and the generally low income generated by children or grandchildren under the age of 18 years old.

Under a TDT, the assets also have greater protection from marriage or relationship breakdown and bankruptcy. In the case of marriage or relationship breakdown, a beneficiary may not be able to transfer assets within a trust to the other spouse. This can assist such thats when there is a breakdown, the assets will not be assets of the relationship.

In the case of bankruptcy, if the beneficiary is bankrupt, the assets can pass to the trustee and not form part of the bankrupt. This may prevent assets from being lost to creditors.

Of course, a TDT may not suit every testator or their beneficiaries, and you should not embark on a TDT will without comprehensive legal advice.

To benefit from the advantages of a TDT, it must be included in your will before death as it cannot be created retrospectively.

** Always obtain independent financial advice when estate planning