Posted Thursday 8th November 2018

How can your Will save your children $123,206 in tax in just 10 years?

What is a testamentary trust?

Unlike a standard Will, which passes the assets or proceeds from your Estate directly to your children, a Testamentary Trust Will creates a commonly used form of trust that is formed upon your death, called a discretionary trust, to own some or all of the assets of the Estate. 

This trust is created for the primary benefit of your children or other beneficiaries and has some very special features and benefits.

What are the tax benefits of a testamentary trust?

Like a normal discretionary trust, the main advantage of a testamentary trust is the ability of the trustee to allocate income to any member of the primary beneficiary’s family, for the purpose of taking advantage of lower tax rates.

This often means allocating income to a spouse that is either working part time or is non-working.

However, a testamentary trust also has the crucial additional benefit that distributions made to minor children (children under 18) under a testamentary trust are taxed as if the child were an adult, meaning that the distribution is tax free up to $18,200 and from then on taxed at the progressive rates. 

Compare this to a discretionary trust formed during your life time (what we call an inter vivos trust) in which any distributions made to minor children from the trust are taxed at the highest marginal rate after the first $416 worth of income.

The best way to demonstrate the advantages of a testamentary trust is to provide a worked example.

Example - minimise tax with a testamentary trust

In this worked example, we look at how a testamentary trust can have massive tax implications for even a relatively modest estate of $500,000 where the primary beneficiary (ie, your child) is in the 31% tax bracket.

The table below compares three scenarios: 

  • Scenario A - Where the beneficiary has simply been gifted the property under the Will and no testamentary trust is in place;
  • Scenario B - Where a testamentary trust has been established to own the investment property; the spouse of the beneficiary is not working and the children have no children under 18 years old;
  • Scenario C - Where a testamentary trust has been established to own the investment property; the spouse of the beneficiary is working, and the couple have two children under 18.

Part 1 – Income tax savings

The trust holds the investment property for 10 years during which:

  • for the purpose of our analysis, we have assumed that tax thresholds and rates remain constant;
  • the primary beneficiary of the trust earns $150,000 from their normal income;
  • the investment property is rented out, and after expenses and maintenance costs, returns a profit of $26,000 per annum.

See below for a comparison of the tax effects between a simple will and a Testamentary Trust Will.  As you can see by Scenario C, your grandchildren can save their parents a lot of tax!

 

SIMPLE WILL

 

TESTAMENTARY TRUST WILL

 

 

SCENARIO A - Beneficiary gifted asset

 

SCENARIO B - Spouse not working, no minor children

 

SCENARIO C - Spouse working, two minor children

 

Income from Estate asset

 

$26,000

$26,000

$26,000

Tax paid on extra income - annual

 

$9,620

$1,482

$0

Tax paid over 10 years on extra income

$96,200

$14,820

$0

Part 2 – Capital Gains Tax savings

After 10 years, the investment property is sold.  The property has increased in value by $200,000 over that time. 

Whether held by the individual beneficiary or by the trust, the 50% capital gains tax discount for holding the asset for more than 12 months applies, leaving a taxable gain of $100,000.

Again, we have assumed the primary beneficiary has an income of $150,000. 

The results for our three scenarios are as follows:

 

SIMPLE WILL

TESTAMENTARY TRUST WILL

 

SCENARIO A- Beneficiary gifted asset

 

SCENARIO B - Spouse not working, no minor children

 

SCENARIO C- Spouse working, two minor children

 

Taxable gain from sale of asset

 

$100,000

$100,000

$100,000

Tax paid per annum on extra income

 

$42,600

$24,632

$15,594

Conclusion

As you can see, in our comparison of the three scenarios, the comparison of the tax result obtained between Scenario A and Scenario C is a difference of a whopping $123,206, whereas the comparison between Scenario A and Scenario B is still a very healthy $99,348.

Note that we have adopted fairly conservative figures in our analysis. These gains would further increase if the taxable income of the primary beneficiary were higher, the property were held for longer, or the increase in value of the property was greater over the 10 years. 

Wills establishing testamentary trusts are more expensive to put in place than a standard Will, and require some specialist knowledge to get right, but as have seen, the initial outlay pales in comparison to the tax savings that are available.

Testamentary trusts also have amazing advantages for protecting your Estate against attacks from your children's creditors and new partners.  For a summary of the asset protection advantages of testamentary trusts please our article Protection from Beyond the Grave: Testamentary Trusts

For a confidential appraisal of your situation and circumstances to determine whether a testamentary trust will may be right for you, please contact us for an initial consultation.

Tags: Estate Planning, Wills, Taxation, Beneficiaries, Minor Children, Testamentary Trusts

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