Understanding How a Testamentary Trust Works

Introduction

Planning what happens to your assets after you’re gone is one of the most powerful ways to take care of your loved ones. For many Australians, a simple Will may not provide enough flexibility or protection — that’s where a can make a real difference.

Used well, a testamentary trust can safeguard your family’s financial future, provide tax benefits, and give you peace of mind knowing that your legacy is protected and distributed exactly as you wish.

Context & Problem

Estate planning isn’t just for the wealthy — it’s for anyone who wants to ensure their assets are passed on smoothly, tax-effectively, and in line with their values.

Without proper planning, assets left in a straightforward Will may:

Become vulnerable to legal claims (such as divorce or bankruptcy)
Lose valuable tax advantages
Be mismanaged or spent unwisely, especially by younger or vulnerable beneficiaries

A testamentary trust addresses these risks by creating a legal structure that manages and protects assets beyond the lifetime of the person who set it up.

Strategy & How To

Here’s a step-by-step breakdown of how a testamentary trust works in Australia:

What Is It?

A testamentary trust is created by your Will and only comes into effect after your death.
The trust holds and manages assets for your chosen beneficiaries.

Who Controls It?

The trustee (often the surviving spouse, a trusted family member, or a professional) manages the assets.
Trustees can appoint accountants or financial planners to help with tax returns and investment advice.

Key Benefits:

Tax Savings: Income distributed to children under 18 is taxed at adult rates (up to $18,200 tax-free as of 2026FY — ATO, updated 1 July 2025), instead of the usual high “penalty” rates for minors.
Asset Protection: Assets in the trust are shielded from legal challenges, bankruptcy, and family law claims.
Flexibility: The trustee can decide how and when income or capital is distributed.

How It Works in Practice:

After death, the executor of the Will applies for probate and transfers assets into the trust.
No stamp duty or capital gains tax applies to this transfer, but owning property in the trust may attract land tax (NSW threshold $1,075,000 at 1.6% = approx. $17,200 as of 2025).
The trustee then manages and distributes assets according to the terms of the trust as established by the Will.

Protecting Vulnerable Beneficiaries:

Ideal for situations involving:
- Minor children
- People with disabilities
- Beneficiaries at risk of divorce, bankruptcy, or financial mismanagement

Case Study

Case Study: Protecting the Next Generation Emma and John have three young children and a family home worth $1.2 million, plus savings and shares. They set up a testamentary trust in their Wills. When John passes away, his share of the assets moves into the trust. Emma, as trustee, controls these assets but they legally belong to the trust — not her personal estate. If Emma later remarries or faces financial hardship, the trust assets are available only for Emma and the children she had with John. As trustee, Emma can distribute income to any of these family members, including the children while still under 18, at adult tax rates. For example, the first $72,800 of taxable income from the trust (4 beneficiaries x $18,200 each) could be distributed to Emma and the children without any tax being incurred. And the children’s income would be controlled by Emma as their parental guardian. When Emma eventually passes, control of the trust passes smoothly to the children, keeping the family wealth intact across generations.

Common Questions & Misconceptions

Q: Do I lose control of my assets if I use a testamentary trust?

A: No. The trustee (often a spouse or trusted person) controls the assets and can also benefit from them by receiving distributions.

Q: Is it only for wealthy families?

A: Not at all. Many everyday Australians use testamentary trusts to protect even modest estates from unnecessary tax or legal risks.

Q: Does it avoid all taxes?

A: No. While income can be distributed tax-effectively, trusts may still face land tax and other obligations. Advice is essential.

Q: Is it expensive to set up?

A: There are legal and accounting costs, but for many, the long-term savings and asset protection outweigh the costs.

Conclusion

A testamentary trust is one of the smartest ways to safeguard your family’s financial future. It gives you control, flexibility, and powerful protection — through clear instructions in your Will.

By taking the time to understand and set up the right structure, you can ensure your hard-earned assets benefit the people you care about most, long after you’re gone.

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Disclosure: General information only. Consider your objectives, financial situation and needs, and seek professional advice before acting.

How We Keep It Trustworthy

Every article includes a Review & Fact Check section below — so you know exactly where our facts come from, what’s uncertain, and whether there’s any bias.

Review & Fact Check

1. Fact References

Testamentary trust tax treatment: Australian Taxation Office (ato.gov.au)
Land tax threshold NSW: Revenue NSW (as of 1 July 2025)
Income tax-free threshold: Australian Taxation Office (ato.gov.au), updated 1 July 2024

2. Unverified or Inconclusive Items

Specific case study is illustrative only — unverified.
Exact legal drafting requirements may vary and should be confirmed with a solicitor.

3. Time Sensitivity

Land tax threshold and rates current as of July 2025.
Tax-free thresholds and income tax rates are subject to change annually.

4. Bias Assessment

Article is neutral and educational, with light promotion of professional advice services.