A Testamentary Trust is usually a discretionary trust which comes into effect upon the death of a person. A discretionary trust is a trust where the person in control of the trust ("the trustee") has the discretion to make trust distributions amongst a variety of potential beneficiaries.
The Testamentary Trust is created in a person's Will, and the intention of the Testamentary Trust is that rather than assets of the deceased person passing directly to beneficiaries in the Will, they are instead transferred into the Testamentary Trust and held in that Testamentary Trust for the beneficiaries.
The Testamentary Trust has a trustee, who exercises his or her discretion as to how to apply the income and assets of the Testamentary Trust to the beneficiaries of the Testamentary Trust.
Ordinarily, the primary beneficiary has the power to remove or appoint the trustee, and the trustee can be the beneficiary themselves.
The main benefit of Testamentary Trusts is for the protection of assets and the reduction of tax liability.
A Simple Example of a Testamentary Trust
A son is the primary beneficiary of a Testamentary Trust established under their deceased father's Will. The son is also the Trustee. The Testamentary Trust will name the son's children, spouse and others to be beneficiaries of the Testamentary Trust.
In any given year, the son (as trustee) can elect at his discretion to make a distribution from the Testamentary Trust to any of the beneficiaries, including himself in whichever proportions that the son thinks reasonable.
One reason for adjusting distributions is that the income of one of the beneficiaries may be substantially lower than that of the son, and a distribution to that beneficiary will have greater tax advantages than the son taking the entire benefit of the distribution in that year.
It may also be the case that no distributions are made, and the Testamentary Trust merely holds assets on trust. Such assets, by being held in that manner, may receive greater protection from creditors in commercial disputes or in the event of matrimonial separation between a beneficiary and their spouse.
Testamentary Trusts can also be used to ensure that estate assets are not squandered by otherwise spendthrift beneficiaries.
Such Testamentary Trusts are sometimes referred to as Protective Testamentary Trusts and the idea behind them is that, unlike a typical Testamentary Trust, the beneficiaries do not have the option or remove or appoint a new trustee.
As a result, that trustee will have the discretion to make distributions from the Testamentary Trust for specific purposes or directly to any third party that requires payment (with that payment being made on behalf of the beneficiary) so that there is no wastage or misuse by the beneficiary of the assets held in the Testamentary Trust.