Estate planning is not just about deciding who receives your assets when you die. It is about making sure your wealth passes to the right people, in the right way, with the right level of protection.

For many families, one of the most effective ways to do this is through a testamentary trust will.

Recent Federal Government tax announcements caused concern that testamentary trusts could lose some of their long-standing tax advantages. Pleasingly, the Government has now clarified its position and confirmed that income from genuine testamentary trusts will be exempt from the proposed 30% minimum tax on discretionary trusts.

That is a significant and positive development for families who use testamentary trusts as part of responsible estate planning.

What is a testamentary trust?

A testamentary trust is a trust created by your will. It does not operate during your lifetime. It only comes into existence after your death, when your estate is administered.

Instead of leaving an inheritance directly to a beneficiary, your will can direct that all or part of that inheritance be held in a separate trust for that beneficiary.

For example, rather than your child receiving their share of your estate personally, their inheritance may be transferred into a testamentary trust controlled by them, or by another trusted person, depending on the terms of your will and the circumstances at the time.

In practical terms, a testamentary trust can allow your beneficiary to enjoy the benefit of their inheritance without necessarily owning the assets personally.

How does it work?

A well-drafted testamentary trust will usually contains the trust rules inside the will itself. After death, the executor administers the estate and then transfers the relevant inheritance into the trust.

Depending on the structure of the will, there may be:

• one trust for a spouse or partner;
• separate trusts for each child;
• trusts for grandchildren or future generations;
• protective trusts for vulnerable beneficiaries; or
• special provisions for beneficiaries with disability, financial risk or relationship difficulties.

In many cases, an adult beneficiary can become the trustee or controller of their own testamentary trust. This gives them practical control over their inheritance, but with added flexibility and protection compared with receiving the inheritance outright.

Key features of a testamentary trust

A testamentary trust can be tailored to suit your family circumstances. Common features include:

1. Flexibility

The trustee can decide how income and capital are used for the benefit of the beneficiaries. This allows the trust to respond to changing circumstances, such as children growing up, education expenses, business opportunities, health needs or family changes.

2. Control

Your will can specify who controls the trust and when. For example, a child may take control once they reach a specified age. Until then, the executor or another trusted person can manage the inheritance for them.

3. Separate trusts for separate beneficiaries

Separate testamentary trusts can be created for different beneficiaries. This can be useful where children have different financial circumstances, family situations or levels of risk.

4. Protection for vulnerable beneficiaries

A testamentary trust can include protective mechanisms for a beneficiary who is young, financially inexperienced, vulnerable, disabled, subject to addiction issues, at risk of bankruptcy or exposed to relationship breakdown.

5. Long-term family wealth planning

A testamentary trust can continue for many years after death. This allows wealth to be managed not just for the immediate beneficiary, but potentially for children, grandchildren and future generations.

The benefits of a testamentary trust

The benefits will depend on each family’s circumstances, but testamentary trusts are commonly used for three main reasons: asset protection, tax flexibility and family control.

Asset protection

If a beneficiary receives an inheritance personally, those assets may become exposed to risks in their personal life.

For example, an inheritance received outright may be at risk if the beneficiary:

• separates from a spouse or domestic partner;
• becomes bankrupt or insolvent;
• is sued;
• operates a business or profession with creditor risk;
• loses capacity;
• is financially vulnerable; or
• later faces a claim against their own estate.

A testamentary trust does not provide absolute protection in every case, but it can significantly improve the position. Because the assets are held in trust, rather than personally owned by the beneficiary, there may be better protection against claims by creditors, former partners or other third parties.

Relationship breakdown is the major cause of wealth loss with Australian families, and protecting that wealth is important for children and grandchildren.

Tax flexibility

One of the major benefits of a testamentary trust is the ability to distribute income between eligible beneficiaries in a tax-effective way.

Under the current tax rules, income distributed to minor beneficiaries from a qualifying testamentary trust can generally be taxed at ordinary adult marginal rates, rather than the penalty rates that usually apply to income distributed to children from a family trust created during lifetime.

This can be especially valuable where a deceased estate includes income-producing assets, such as shares, investment properties, cash, life insurance proceeds or superannuation death benefits paid into the estate.

For example, a surviving spouse with young children may be able to use a testamentary trust to distribute income to children in a way that helps fund school fees, living expenses and family needs more tax effectively.

The tax treatment is subject to important rules. In particular, the favourable treatment generally applies to income derived from assets that came from the deceased estate, or from the reinvestment of those assets. It is not a general licence to inject unrelated assets into the trust and obtain concessional tax outcomes.

Capital gains tax planning

A testamentary trust can also be useful where the estate includes growth assets, such as shares, investment portfolios, business interests or real estate.

In many cases, assets can pass from the deceased estate into a testamentary trust without triggering capital gains tax at that time. If assets are later sold by the trustee, the trust structure may provide flexibility in how capital gains are distributed between beneficiaries.

This can help reduce tax leakage and preserve more wealth for the family.

The Government’s proposed 30% trust tax

The Federal Government has proposed a new 30% minimum tax on discretionary trust income from 1 July 2028.

When first announced, there was concern that the measure could apply to future discretionary testamentary trusts. That caused understandable alarm among lawyers, accountants, advisers and families who rely on testamentary trusts for legitimate estate planning.

The concern was simple: if testamentary trusts were caught by the new 30% minimum tax, one of the most important estate planning tools available to Australian families would have been significantly weakened.

It could have reduced the tax flexibility of testamentary trusts and made them less attractive for families with young children, vulnerable beneficiaries, blended family arrangements or asset protection concerns.

The Government’s backflip: good news for families

The Government has now clarified that income from all types of testamentary trusts will be exempt from the proposed 30% minimum tax, provided the trust is established for genuine testamentary purposes. This is a welcome and sensible outcome.It recognises that testamentary trusts are not simply tax planning vehicles. They are commonly used for legitimate family, protective and succession planning purposes.

They help parents provide for young children. They help protect vulnerable beneficiaries. They help manage inheritances after relationship breakdown, bankruptcy, incapacity or premature death. They help preserve family wealth across generations.

The Government has also indicated that integrity measures will apply. This means the exemption is likely to be directed at genuine testamentary trusts funded from deceased estate assets, rather than trusts used to introduce unrelated assets after death for tax reasons.

That is consistent with the existing direction of the tax law.

What does this mean for your estate plan?

The backflip means testamentary trusts remain a powerful and relevant estate planning option.

For many clients, the case for a testamentary trust will is now stronger, not weaker.

A testamentary trust may be particularly worth considering if:

• you have children or grandchildren;
• you have a blended family;
• you have a beneficiary in a high-risk occupation or business;
• you are concerned about relationship breakdown affecting an inheritance;
• you want to protect vulnerable or financially inexperienced beneficiaries;
• your estate includes life insurance, superannuation death benefits, investment assets or business interests;
• you want to preserve wealth for future generations; or
• you want your beneficiaries to have flexibility after your death.

Is a testamentary trust compulsory?

No. A Hill Legal drafted testamentary trust will can often give beneficiaries the choice of whether to use the trust.  In some cases, a beneficiary may decide to receive their inheritance personally. In other cases, they may decide to place some or all of their inheritance into the testamentary trust because of the asset protection, tax or family planning benefits.  However, where a beneficiary is young, vulnerable or specifically protected under the will, the trust may be mandatory or controlled by another person for a period of time.

Can a testamentary trust be added later?

Generally, no.

A testamentary trust should be created in your will before you die. In most cases, beneficiaries cannot simply create the same structure after your death and obtain the same legal and tax benefits. That is why it is important to consider testamentary trust provisions when preparing or reviewing your will.

The takeaway

A testamentary trust is one of the most flexible and protective estate planning tools available. It can help ensure that your estate is not simply handed over, but carefully structured for the benefit of the people you care about most.

The Government’s recent clarification is a positive development. It means that genuine testamentary trusts should continue to provide important tax flexibility, asset protection and family wealth planning benefits.

For clients who already have testamentary trust wills, this is reassuring news.

For clients who do not, now is an excellent time to review whether a testamentary trust should form part of your estate plan.

Estate planning is not only about who receives your wealth. It is about how they receive it, how it is protected, and how it can be used to support your family for years to come.

A testamentary trust can help achieve exactly that.

If you’re not sure whether you have a testamentary trust in your will that has the features described above, please contact  the team at Hill Legal’s estate planning department on 03 5976 6500 or send us a message to discuss this issue further with your circumstances.