BY WEALTH ADVISER
Most people think of a will as a fairly straightforward document — it says who gets what when you die. And for many families, a simple will does the job well enough. But as wealth grows, family structures become more complex, and the tax and legal landscape shifts, an increasing number of Australians are discovering that how they leave assets can matter just as much as what they leave.
A testamentary trust is one of the most powerful tools available in estate planning, yet it remains one of the least understood. At its core, the concept is not complicated: instead of leaving assets directly to your beneficiaries, your will directs some or all of your estate into a trust that is managed on their behalf. The trust only comes into existence when you die — it is created by the will itself — and it can continue for decades, providing tax advantages, asset protection and flexible income distribution to your family long after your estate has been settled.
Understanding what a testamentary trust does, how it works, and where it fits in your broader planning can open up possibilities that a simple will simply cannot deliver.
What a Testamentary Trust Actually Does
When someone dies and their will directs assets into a testamentary trust, those assets are held and managed by a trustee rather than being handed over to beneficiaries outright. The trustee — who might be a family member, a professional trustee company, or a combination of both — then has the discretion to distribute income and capital to the beneficiaries named in the trust, according to the terms set out in the will.
This creates a layer of structure between the inheritance and the beneficiary. That structure serves several purposes, but the two that matter most to families are tax efficiency and asset protection.
The tax advantages flow from the way the law treats income earned inside a testamentary trust. Normally, if a family trust distributes income to a child under 18, penalty tax rates apply under Division 6AA of the Income Tax.
Assessment Act 1936. The tax-free threshold drops to just $416, with rates of 66 per cent on the next band of income and the top marginal rate of 45 per cent thereafter. This makes sense as a policy measure: it prevents parents from simply shifting investment income into their children’s names to avoid tax.
But testamentary trusts are treated differently. Income distributed from a testamentary trust to a minor beneficiary — provided it is derived from assets that came from the deceased estate — is classified as “excepted trust income” and is exempt from those penalty rates. This means the child is taxed at normal adult marginal rates, including access to the $18,200 tax-free threshold and the low income tax offset.
In practical terms, a child with no other income could receive up to approximately $22,575 in income from a testamentary trust in the 2025-26 financial year without paying any income tax at all — the combination of the $18,200 tax-free threshold and the $700 low income tax offset reduces the tax payable to zero. Medicare levy also does not apply at that income level due to low-income thresholds. By contrast, the same distribution from an ordinary family trust would attract penalty tax of more than $10,000.
For a family with three children under 18, a well-structured testamentary trust could shelter a meaningful amount of investment income each year — not through any artificial arrangement, but simply through the way the law treats inherited wealth.
It is worth noting that this concession was tightened from 1 July 2019. The concessional tax treatment now only applies to income generated from assets that were transferred to the trust from the deceased estate, or from the reinvestment of those assets. Money or assets injected into the trust from other sources — such as a distribution from a family trust or additional funds contributed after the death — will not attract the same treatment. This means careful record-keeping and clear separation of estate assets within the trust is essential from day one. Your adviser and accountant can help ensure this is managed correctly.
Asset Protection: Keeping Wealth in the Family
Tax efficiency tends to get the headlines, but for many families the asset protection benefits of a testamentary trust are equally valuable — and arguably more enduring.
When you leave assets directly to a beneficiary, those assets become part of their personal estate the moment they receive them. That exposes the inheritance to a range of risks: a relationship breakdown, a business failure, a lawsuit, or even simply poor financial management. A child who inherits $500,000 at 25 and goes through a divorce at 30 may find that a significant portion of that inheritance is treated as part of the matrimonial asset pool.
Assets held inside a testamentary trust, by contrast, are legally owned by the trustee — not the beneficiary. While family law courts retain the discretion to consider trust assets in property settlements, the trust structure creates a meaningful barrier. Courts have generally treated assets held in a testamentary trust — one that the beneficiary did not create and does not control — with more deference than assets the beneficiary holds personally.
This distinction also extends to creditor protection. If a beneficiary faces bankruptcy or is sued, assets held within a testamentary trust can offer significantly stronger protection than assets held personally, because the beneficiary does not own the assets outright. The trustee holds them on the beneficiary’s behalf, and the beneficiary’s entitlement is at the trustee’s discretion. However, outcomes depend on the specific trust terms, the beneficiary’s role in the trust, and the circumstances of any claim — so the protection, while meaningful, is not absolute.
For parents leaving assets to adult children who are professionals with liability exposure — doctors, company directors, builders, financial advisers — or who run their own businesses, this protection can be the most compelling reason to consider a testamentary trust.
How Testamentary Trusts Are Established
A testamentary trust is created through your will. It does not exist during your lifetime and has no legal effect until you die. This means the drafting needs to be done by an experienced estate planning solicitor who understands both the legal requirements and the practical implications.
The will itself sets out the terms of the trust: who the trustee is, who the beneficiaries are, what assets flow into the trust, and how the trustee should manage and distribute those assets. Most testamentary trusts are established as discretionary trusts, meaning the trustee has broad discretion to decide how much income or capital each beneficiary receives in any given year. This flexibility is one of the trust’s greatest strengths — it allows the trustee to adapt distributions to the changing circumstances of each beneficiary over time.
Some wills create the trust as an automatic structure that takes effect on death. Others make it optional — giving the executor or a beneficiary the choice of whether to activate the trust based on the circumstances at the time. This optional approach can be particularly useful because it allows the decision to be made with the benefit of hindsight, taking into account the tax position, asset composition and family situation that exist at the time of death rather than the time the will was written.
You can establish a single testamentary trust for your entire estate, or create separate trusts for different beneficiaries. Separate trusts give each beneficiary their own structure and prevent disputes about how income and capital are shared, but they also add administrative complexity and cost.
The key structural decisions — discretionary versus fixed entitlements, single versus multiple trusts, who acts as trustee — should be made in consultation with your solicitor and your financial adviser, because they have lasting implications for how the trust operates and how much flexibility it provides.
Choosing the Right Trustee
The trustee appointment is one of the most consequential decisions in the entire structure, and it is often the one that receives the least thought.
The trustee is the person or entity who will manage the trust assets, make distribution decisions, lodge tax returns, and exercise the discretions granted by the will. They are legally responsible for acting in the best interests of the beneficiaries, and their role can last for decades.
Many people appoint their surviving spouse as the initial trustee, with provisions for the role to pass to another family member or a professional trustee if the spouse is unable to continue. Others appoint an adult child, a trusted family friend, or a professional trustee company from the outset.
Each choice carries trade-offs. A family member may understand the family dynamics better and may act without charging fees, but they may also face conflicts of interest — particularly if they are both trustee and beneficiary. A professional trustee brings independence and expertise, but at a cost, and they may lack the personal understanding of the family’s needs and values.
The wrong trustee appointment can undermine the entire purpose of the structure. A trustee who is too generous with distributions may deplete the trust earlier than intended. One who is too conservative may frustrate beneficiaries who have legitimate needs. And a trustee who lacks the financial literacy to manage investments and meet tax obligations can create compliance problems that are expensive to fix.
It is worth revisiting your trustee appointment periodically. Relationships change, health deteriorates, and people move overseas. Your will should include succession provisions for the trustee role, and your adviser can help you think through the scenarios that might require a change.
Common Mistakes That Undermine the Structure
Testamentary trusts are powerful when they are well designed and well maintained, but several common mistakes can erode their effectiveness.
The most frequent problem is simply failing to update the will after major life changes. A will drafted when your children were minors may not reflect the right structure once they are adults with their own families and financial circumstances. Divorce, remarriage, the birth of grandchildren, the death of a named trustee, or a significant change in the size or composition of your estate can all render an existing testamentary trust structure inadequate or even counterproductive.
Another common error is failing to coordinate the testamentary trust with superannuation death benefit nominations. Your super does not automatically form part of your estate — it is paid according to a binding death benefit nomination, or at the discretion of your fund’s trustee. If your will creates a carefully structured testamentary trust but your super is paid directly to a beneficiary outside that trust, a substantial portion of your wealth bypasses the structure entirely.
For the trust to capture super proceeds, the death benefit generally needs to be directed to your estate (via a binding nomination to your legal personal representative), from where the executor can then transfer the funds into the testamentary trust. However, this approach has its own considerations — many funds only allow binding nominations to certain categories of beneficiary, and nominations can lapse or become invalid if not renewed. There is also the tax treatment of death benefits paid to non-dependant beneficiaries (which can attract a tax liability that would not arise if the benefit were paid directly to a tax dependant) and the potential for the estate to be exposed to creditor claims during the administration period. Getting this right requires close coordination between your financial adviser, your solicitor and your super fund.
Injecting non-estate assets into the trust after death is another pitfall. Since the 2019 changes to Division 6AA, the concessional tax treatment for minors only applies to income from assets that originated in the deceased estate. If the trustee borrows money, receives distributions from an existing family trust, or accepts additional contributions from other family members, the income generated from those assets will not receive the same tax treatment. This can create a mixed pool of assets within the trust that requires careful tracking and separate calculations — adding cost and complexity.
Finally, some families establish testamentary trusts without considering the ongoing administration burden. A testamentary trust is a separate taxpaying entity. It needs its own tax file number, its own annual tax return, and its own financial records. The trustee must make and document distribution resolutions each year, maintain appropriate investment records, and comply with all relevant trust law obligations. These costs and responsibilities need to be weighed against the benefits, particularly for smaller estates where the administrative overhead may outweigh the tax and protection advantages.
When a Testamentary Trust Makes Sense — and When It May Not
A testamentary trust is not the right answer for every estate. The decision depends on the size and nature of your assets, the composition of your family, and the specific risks you are trying to manage.
The structure tends to add the most value when there are minor beneficiaries who would benefit from the concessional tax treatment, when beneficiaries face professional liability or business risk, when there is concern about a beneficiary’s ability to manage a large inheritance responsibly, when family relationships are complex and a direct distribution could create conflict, or when the estate is large enough to justify the ongoing administration costs.
For smaller estates, or for families where the beneficiaries are financially stable adults with no particular asset protection concerns, a simple will with direct bequests may be perfectly adequate. The testamentary trust adds value through its structure, but that structure comes with costs — legal fees to draft, accounting fees to administer, and the ongoing responsibility of trusteeship. Your adviser can help you assess whether the benefits outweigh those costs in your particular circumstances.
Discussion Points for Your Adviser
If you are reviewing your estate plan — or creating one for the first time — a conversation about testamentary trusts is worth having. Your adviser can help you consider whether the size and composition of your estate would benefit from a trust structure, how your superannuation death benefit nominations interact with your will, whether your current trustee appointments remain appropriate, how the tax advantages apply to your specific family situation, and whether your will has been updated to reflect any changes in your circumstances since it was last reviewed.
Estate planning sits at the intersection of legal, tax and financial advice. Your financial adviser, solicitor and accountant each bring a different perspective, and the best outcomes tend to come from all three working together. If your will was drafted some time ago — or if you have never considered whether a testamentary trust might be relevant — raising the topic with your adviser is a sensible first step.
References
1. Income Tax Assessment Act 1936 (Cth), Division 6AA, s102AG. Provisions relating to excepted trust income for testamentary trusts.
2. Australian Taxation Office. “Your income if you are under 18 years old.” ATO guidance on excepted trust income and testamentary trusts (ato. gov.au).
3. Treasury Laws Amendment (2019 Tax Integrity and Other Measures No. 1) Act 2019. Changes to excepted trust income provisions for testamentary trusts, effective 1 July 2019. See also: Treasury Exposure Draft Explanatory Materials.
4. Australian Taxation Office. “Tax rates — Australian residents” for 2025- 26 income year (ato.gov.au).
5. Australian Taxation Office. “Low income tax offset” (ato.gov.au). Maximum offset of $700 for taxable incomes up to $37,500.
6. Australian Taxation Office. “Superannuation death benefits” — guidance on binding death benefit nominations and payment to legal personal representative (ato.gov.au).
7. Australian Taxation Office. “Medicare levy reduction for low-income earners” (ato.gov.au).
