The Albanese government’s recent walk-back on the proposed tax treatment of discretionary testamentary trusts (DTTs) has put these structures in the public spotlight, piquing the interest of Australians who like the sound of a trust that, at this stage, remains an exception to the government’s looming 30% minimum tax on discretionary trusts.
But while the potential tax advantages are driving the recent surge of interest in DTTs, they are only part of the story. A DTT can be a powerful tool in your estate planning kit, but only when it is properly aligned with the assets and structures that sit around it.
That means the question is not whether a DTT offers advantages, but whether this type of structure melds with your overall position and what you’re actually wanting to achieve for your family.
How testamentary trusts work
A testamentary trust is a trust created through your will. Unlike a trust established during your lifetime, it only comes into effect after your death, when certain assets from your estate are transferred into the trust and managed for the benefit of your chosen beneficiaries.
Testamentary trusts can be fixed or discretionary, with discretionary being more common by a country mile. In a DTT, your elected trustee has discretion over how income and capital are distributed between the beneficiaries, within the bounds of the will.
That flexibility is a major part of their appeal. Rather than assets passing directly to beneficiaries, DTTs allow those assets to be managed over time, with decisions made according to the needs and circumstances of the people you want to provide for.
Potential tax advantages are one piece of a much bigger picture
Recent media coverage has consistently put DTTs in the same sentence as ‘taxation’, but tax effectiveness alone is not enough of a reason to establish one.
Back in May, when the government first flirted with the potential of amping up tax rates for DTTs, it forced my clients and I to take a step back and revisit why their DTT was set up in the first place.
Was it mostly about tax minimisation? Or asset protection?
Most of the time, my clients would have a laugh and say “both”, however when we got down to the core reason, asset protection would usually prevail as their original reason why.
The main drawcard of DTTs is that they can give you greater control over how your assets are distributed. And so, with greater control, comes greater protection.
Rather than distributing wealth directly to a beneficiary, a DTT allows assets to be held in trust and managed by your elected trustee, giving more structure around how your wealth can be accessed and used.
The specifics of how these controls come into play will be different for each DTT, based on the trust deed, which is precisely the point. But in broad terms, a DTT can help you decide when, how, and why assets are made available to a beneficiary. It may allow you to:
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Delay access to capital
This can be useful where a beneficiary is young, vulnerable or financially inexperienced, and you do not want them to receive a large inheritance before they are ready to manage it. -
Direct funds towards specific purposes
Rather than giving a beneficiary unrestricted access to assets, the trustee may be able to pay expenses on behalf of the beneficiary. Most often, this setup is designed to accommodate bigger life expenses, such as housing, education, and healthcare. -
Keep assets separate from the beneficiary’s personal control
Keeping assets housed in the trust, rather than in the beneficiary’s name may offer greater protection if the beneficiary later faces bankruptcy or financial fallout triggered by business failure or relationship breakdown.
In this sense, a DTT is a structure that can protect your wealth and the people you’re wanting to support with it. However, there is a fine line between ‘can’ and ‘will’.
By nature, estate planning is intricate. For an estate plan to work as intended, all of your assets and all of your structures need to be in alignment with one another.
And when you’re operating with a level of financial complexity, as our clients are, getting and keeping the individual elements in unison requires deep, meticulous, and ongoing work.
That is particularly true when you consider how much can change from year to year: Families change, relationships change, businesses change; assets are bought, sold, and restructured. So even when you’ve got the right structures in place, they need to be reviewed regularly and considered as an individual part of the whole to ensure the entire architecture is set up in a way that facilitates your wishes.
A key part of that is understanding the pathway each asset will take when you die.
Because while your will may establish a DTT, your will does not necessarily control every asset you own. In some cases, the pathway is determined by the structure that holds the asset now or the rules it’s governed by.
That means there can be a real gap between what your will says and what actually happens. Whether you’re thinking about establishing a DTT, or you already have one, there are a few important things to know:
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Superannuation may not automatically pass through your will
Wills and estate planning are dealt with under state-based rules, while superannuation is governed under a federal system. This means your super does not automatically form part of your estate, and will only flow into a DTT if the right arrangements are in place.
Depending on the structure, your super may be paid to your estate, where it can then be dealt with under your will and potentially pass into the DTT.
In other cases, it may bypass the estate altogether. For example, your super may be paid directly to a nominated beneficiary under a binding death benefit nomination. Or, where a reversionary pension has been established, it may be directed to your spouse in the wake of your passing. Where that happens, the benefit does not pass through your will and will not be controlled by the trust.
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Insurance may not sit where you think it does
The same issue can arise with insurance. A will might refer to a specific insurance policy and direct it to a particular child, beneficiary, or your DTT. But if that policy is actually owned inside superannuation (or by another person), it may be dealt with as part of the superannuation, rather than as a separate asset controlled by the will.
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Joint assets may bypass the estate altogether
Jointly owned assets follow their own pathway. In most cases, a jointly held asset passes directly to the surviving owner, rather than through the estate. So while your will may establish a DTT, jointly held assets may never form part of the trust.
This is not necessarily a problem. In many cases, it is exactly how the asset is intended to pass. But it needs to be understood as part of the broader estate plan, particularly where the will assumes certain assets will be available to fund the trust.
A DTT can be a useful tool for estate planning, but it is not a structure you can set up once and forget.
Changes to your assets, family circumstances, or structures can have a very real impact on whether your estate plan works as intended.
Used well, a DTT can give you greater control over how your wealth is protected and distributed after your death. But that control only works if the assets you expect to pass into the trust are able to get there.
If this article has left you with questions about your own estate plan, please get in touch with me or the Ulton Wealth team.
