I have written before about estate planning – wills, powers of attorney, super, and the like (here in 2018 and here in 2020). That said, we keep getting the same questions on a few topics, so I thought it was worth taking a closer look at them.
Beware of higher tax rates for children
Minors (i.e., individuals under 18) are taxed differently to adults when it comes to unearned income such as interest, dividends, and capital gains. The first $416 of unearned income is tax-free, but any amount above this is taxed at 47% – the highest marginal tax rate. This penalty tax regime is designed to prevent adults from diverting income to children to reduce their overall tax liability.
However, there is one important exception. If a minor receives income because of a will or through a testamentary trust, that income is taxed at normal adult rates. This is called excepted income. In other words, the child can benefit from the standard $18,200 tax-free threshold, and lower marginal tax rates thereafter. This tax concession is not exclusive to testamentary trusts. It applies to any income a minor receives because of a deceased estate.
What is a testamentary trust
A testamentary trust is simply a discretionary trust that is established via a person’s will. The trust deed, which sets out the rules of the trust, is included in the will itself. Typically, the trustee is either the executor of the will or the primary beneficiary (if they are over 18). Alternatively, a company can be appointed as trustee.
Most testamentary trust deeds provide very broad powers. For example, the trustee is usually able to distribute income and capital to a wide range of beneficiaries and can allocate different types of income (such as franked dividends or capital gains) to different beneficiaries, depending on what’s most tax effective.
Protecting wealth from relationship breakdowns
From an asset protection perspective, relationship breakdowns statistically pose the greatest risk, and it’s a risk that’s impossible to quantify if your beneficiaries are not yet in long-term, stable relationships.
Consider this scenario: you pass away and leave an inheritance to your child, only for them to separate from their partner shortly afterwards. In that case, their former spouse could be entitled to claim 50% or more of the inherited assets.
To mitigate this risk, one option is to restrict testamentary trust beneficiaries to direct descendants only, sometimes referred to as a “bloodline trust”. This structure offers strong protection against claims from in-laws during a relationship breakdown. However, the trade-off is reduced flexibility in distributing income across family members, which may limit tax planning opportunities.
A more flexible alternative is to structure beneficiary entitlements based on their relationship status and whether they have a Binding Financial Agreement (BFA or “pre-nup”). If a beneficiary is in a relationship and has a BFA that explicitly excludes capital distributions from the testamentary trust being included in the relationship’s asset pool, they can receive both income and capital. If no BFA exists, the trust can be drafted so that they are only entitled to income, not capital.
This approach helps preserve the flexibility to minimise tax whilst still protecting the underlying capital from potential relationship claims.
Why do people include testamentary trusts in their wills?
If you hold substantial assets in your personal name, rather than in a company, trust, or superannuation, it’s worth considering including a testamentary trust in your will. There are several compelling reasons why this structure can offer significant advantages:
Tax efficiency for minors
A testamentary trust allows income distributions to minors to be treated as “excepted income”, which means they benefit from the adult tax-free threshold and marginal tax rates. Whilst this can be achieved without a testamentary trust, quarantining capital inside a testamentary trust keeps record-keeping clean, ensuring these tax benefits are preserved and fully utilised.
Flexibility
A testamentary trust gives the trustee discretion over how to distribute income, capital gains, and dividends among beneficiaries. This flexibility allows for optimal tax planning and financial management. In addition, if some assets are likely to be retained for many years after your death, pooling them within the trust gives the executor the ability to equalise distributions over time, a particularly useful feature where asset values may vary or change.
Asset protection
Because assets are held by the trust rather than by individuals, they can be protected from creditors, legal disputes, bankruptcy, and potentially even from family law claims brought against beneficiaries.
Control over access
You can specify the age at which a minor gains control of their inheritance, for example, age 21 or 25, rather than the default of 18. In the meantime, funds can still be accessed to cover their living expenses and certain other costs, such as education, medical needs, or a first home deposit.
Can you contribute money into a testamentary trust?
While it’s possible to contribute additional capital to a testamentary trust after it has been established, doing so will dilute the proportion of capital that originated from the estate. This, in turn, reduces the amount of income that qualifies as “excepted income” for minors, thereby diminishing the associated tax benefits.
For this reason, we typically recommend against introducing additional capital or borrowings into a testamentary trust. Preserving the original estate capital ensures the full extent of tax concessions that can be maintained and maximised.
Practical uses of a testamentary trust
There are several practical and strategic ways to structure and utilise a testamentary trust. Here are a few common examples:
Intergenerational education fund
You may choose to allocate part or all of your estate into a dedicated testamentary trust, specifically designed to fund educational expenses, such as private school or university fees. With prudent investment and management, this trust could potentially span multiple generations, supporting the education of grandchildren and beyond.
That said, unless the trust has its “closest and most substantial connection” to South Australia (which has abolished the rule), testamentary trusts are subject to an 80-year vesting rule. To address this, it may be worth including a provision that ensures any remaining capital is distributed evenly among descendants if it is not used for education purposes before the trust vests.
Supporting at-risk beneficiaries
Some beneficiaries may need greater oversight. For example, individuals with addictions (such as gambling or alcohol), those with poor financial judgment, or people living with a disability. In such cases, the testamentary trust can be structured to provide only modest, regular income distributions, and limit access to larger lump sums. This approach ensures beneficiaries are supported without placing the capital at undue risk.
Large families and many grandchildren
One of our clients received a substantial inheritance and has seven grandchildren. Last financial year, the testamentary trust distributed $240,000 in income and capital gains evenly among the 7 grandchildren. Thanks to franking credits, each grandchild received a tax refund of nearly $2,000, generating more than $12,000 in total tax refunds. That’s an incredibly tax-effective outcome, and one that’s only possible via a properly structured testamentary trust.
Pairing a testamentary trust with a Public Ancillary Fund (PAF)
If your wishes include donating a portion of your estate to charity, consider using a Public Ancillary Fund (PAF), such as the APS Foundation, alongside a testamentary trust. PAFs are registered charities that qualify as deductible gift recipients, meaning the trust receives a tax deduction when donating to a PAF.
Here’s how this might work in practice: suppose the testamentary trust holds an investment property that has appreciated significantly over decades. If the property is sold and a large capital gain is realised, the trust could gift a portion of the proceeds to a PAF to offset the tax liability. Without a PAF, any charitable donations would need to be made directly to eligible charities in the same financial year, which can feel rushed or overwhelming. A PAF allows donations to be spread over time (at least 4% per year), providing more control, and improves tax efficiency.
Borrowing from the trust instead of distributing capital
Often, beneficiaries who inherit money in their 30s or 40s want to use it to reduce their home loan, upgrade, or renovate this home. However, they may also want to preserve the long-term benefits of the testamentary trust. In these cases, it can make sense for the trust to lend the capital to the beneficiary, rather than distribute it outright. This allows the individual to use the funds today while retaining the option to repay the loan later and continue to benefit from the trust’s favourable tax treatment. It is important to check if the Deed allows for these arrangements. If a testamentary trust has multiple primary beneficiaries (for example, siblings) then any loans made to beneficiaries will usually need to be structured on commercial terms. This is one reason why including the option to establish multiple testamentary trusts in a will is advantageous.
Handing over control of entities
Your will can be structured so that any personally held assets are passed into one or more testamentary trusts. However, if you also control entities such as companies or trusts, you will need to think carefully about how control of those entities will be handed over.
Trusts
Assuming the trust deed permits it, which most modern deeds do, control of a discretionary trust is typically passed on by nominating a successor appointor in your will. The appointor holds significant power, as they can appoint and remove the trustee, and therefore indirectly control the trust.
Companies
Shares in a private company that are held in your personal name will form part of your estate and be distributed according to your will. However, it’s the directors of a company who exercise day-to-day control, not the shareholders.
The company’s constitution will dictate how directorships are handled after death. Some constitutions allow you to nominate a successor director. If your company has only one director, legislation allows your executor to appoint a replacement director, but you must ensure your will gives them the authority to do so.
Alternatively, you may choose to execute a Company Power of Attorney, which allows someone else to act on your behalf in managing the company if you become incapacitated or upon death.
What about superannuation inheritance tax
Your superannuation does not automatically form part of your estate and therefore does not pass under your will. Instead, the trustee of your super fund must decide who receives your superannuation death benefit. This decision is typically guided by your death benefit nomination, ideally a binding one, which ensures your wishes are followed.
If your super is paid to a tax-dependent beneficiary, such as a current or former spouse, a child under 18, or someone who is financially dependent or in an interdependent relationship with you, then the entire benefit is received tax-free.
However, if your super is paid to a financially independent adult child for example, the taxable component of your super balance will be subject to a flat tax rate of 17% (including the Medicare levy). The tax-free component remains exempt from tax. This is often referred to as the “super inheritance tax”.
My colleague, Campbell Wallace, will be publishing a detailed blog and podcast on 1st of October 2025 that explores this topic in depth, including strategies to reduce or potentially avoid this tax altogether.
Are your parent’s wills structured correctly?
If you expect to be a beneficiary of a will, it’s worth considering, where possible and practical, whether the will includes appropriate structures to help you manage the inheritance effectively and minimise any unnecessary tax consequences. While these conversations can be sensitive, ensuring the will includes provisions such as a testamentary trust can make a meaningful difference to long-term outcomes.
Part financial and part legal advice
Your will should be as simple as possible, but no simpler. A good financial advisor can help determine how your will ought to be structured, considering your broader financial strategy, investment structures, and family dynamics.
But when it comes to the legal drafting, it’s essential to engage an experienced estate planning lawyer to get the detail right. Precision matters. Poorly drafted documents can undermine your intentions and lead to avoidable tax, delays, or disputes.
