A testamentary trust is a trust created through a person’s will that comes into effect after they die. It holds assets for beneficiaries and offers significant tax advantages, particularly for minor children who can be taxed at adult rates on trust income, along with asset protection and control over how the inheritance is used.
This guide is part of our complete guide to trusts in Australia.
Most Australians have a will. But having a will and having a will that actually protects your family’s wealth are two very different things. A will that simply divides your estate between your beneficiaries — however well-intentioned — leaves that wealth exposed to tax, creditors, relationship breakdowns, and poor financial decisions the moment it changes hands.
A testamentary trust changes that. It is the estate planning structure that wealthier families have relied on for decades, and one that remains vastly underutilised by everyday Australians who could benefit most from it.
In this guide, we explain exactly what a testamentary trust is, how it works, and why it may be the most important estate planning decision you make for your family.
What Is a Testamentary Trust?
A testamentary trust is a legal trust created by the terms of your will that comes into existence only upon your death. Unlike a family trust (also called an inter vivos trust or living trust), which you establish and control during your lifetime, a testamentary trust does not exist while you are alive — it is created by your will and activated when your estate is administered.
The trust is established through a specific clause in your will — the trust deed — that sets out who the trustee is, who the beneficiaries are, and how the assets should be managed and distributed. When you die, instead of your estate passing directly to your beneficiaries, it passes into the testamentary trust. The trustee then manages those assets on behalf of the beneficiaries according to the terms you specified.
You can have a single testamentary trust covering all beneficiaries, or separate trusts for each child or family group. Most estate planning advisers recommend a separate trust for each branch of the family to maximise flexibility and protection.
How Does a Testamentary Trust Work?
The mechanics are straightforward. When you die, your estate is first administered through probate — the legal process of validating your will. Once probate is granted, instead of the assets being distributed directly to your beneficiaries, they flow into the testamentary trust. The trustee takes legal ownership of those assets and manages them for the benefit of the beneficiaries.
In a discretionary testamentary trust, the trustee has full discretion to distribute income and capital to any beneficiaries within the trust’s defined class, in any proportions, at any time. This flexibility is central to the trust’s tax efficiency.
A simple example illustrates the difference:
Imagine a parent dies leaving an $800,000 estate to their three adult children. Under a simple will, each child receives approximately $267,000 directly. That money becomes part of their personal wealth — taxed in their name, accessible to their creditors, at risk in any relationship breakdown.
Under a testamentary trust, the $800,000 flows into a trust managed by a trustee. The trustee invests the assets and each year distributes income — say, 5% returns generating $40,000 — across the family group in the most tax-effective way. The trustee can distribute to adult children, their spouses, and importantly, their minor children (grandchildren of the deceased), splitting income across multiple tax-free thresholds. None of the capital is immediately at risk from any single beneficiary’s personal circumstances.
The Tax Advantage That Makes Testamentary Trusts Exceptional
The most significant benefit of a testamentary trust — the one that separates it from every other estate planning structure — is how minor beneficiaries (children under 18) are taxed on distributions.
Under Division 6AA of the Income Tax Assessment Act 1936, income distributed to minor children from living trusts (such as family trusts or discretionary trusts established during your lifetime) is taxed at punitive penalty rates. A child receiving $18,200 from a family trust pays tax at the top marginal rate on amounts over $416 — resulting in an effective tax rate approaching 66% on that income. This is commonly called the kiddie tax.
However, under section 102AG of the Income Tax Assessment Act 1936, income distributed to minors from a testamentary trust is treated differently. It is taxed at ordinary adult marginal tax rates — not the penalty rates.
This means a 10-year-old grandchild receiving $18,200 in income distributions from a testamentary trust pays zero tax — that amount sits precisely at the tax-free threshold for an adult. The same child receiving $18,200 from a family trust would face a tax bill of approximately $12,000.
For a family with multiple minor grandchildren, this difference compounds significantly year after year. It is the primary reason that high-net-worth families and business owners structure their estates around testamentary trusts rather than simple direct inheritances. The ATO provides guidance on deceased estates and testamentary trusts and how income distributions are assessed.
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Book a Consultation SessionOther Key Benefits of a Testamentary Trust
Tax efficiency for minor beneficiaries is the headline benefit, but testamentary trusts offer a range of protections that make them valuable for almost any estate above $500,000.
Asset Protection from Creditors
Assets held in a testamentary trust are legally owned by the trust, not the individual beneficiary. This means those assets are generally protected from the beneficiary’s creditors — whether arising from a business failure, personal bankruptcy, or a court judgment. If a beneficiary faces financial difficulty, the trustee can suspend or redirect distributions until the risk passes. The trust assets remain intact and out of reach.
Protection in Relationship Breakdown
Under Australian family law, trust assets can be treated differently to personal assets in property settlements. Assets held in a testamentary trust — particularly where the beneficiary does not have direct control over distributions — may receive a degree of protection from a separating spouse’s claims, compared to assets received directly as an inheritance. Speak with your legal adviser about how this applies to your specific circumstances.
Flexibility for Changing Circumstances
Life changes. A simple will cannot account for changes in a beneficiary’s tax situation, financial needs, or personal circumstances that happen years after your death. A testamentary trust gives the trustee ongoing discretion to adjust distributions as circumstances evolve — directing more income to a beneficiary who needs it, or less to one who is already in a high tax bracket.
Control and Conditions
As the will-maker, you can set conditions on how and when capital is accessed. For example, you might specify that a beneficiary cannot access trust capital until they turn 25, ensuring that young adults have time to mature before receiving a significant inheritance. This level of control is impossible with a simple direct inheritance.
Blended Family Protection
For those in second marriages or blended families, a testamentary trust provides a mechanism to ensure assets ultimately reach your intended beneficiaries — your children from a previous relationship — rather than passing to a surviving spouse who may later remarry or leave the estate to unintended parties.
Testamentary Trust vs Family Trust — What Is the Difference?
Many Melbourne business owners already have a family trust and wonder how a testamentary trust relates to it. They serve different purposes and are not interchangeable. For a broader overview of all Australian business structures — including how family trusts, companies, and multi-entity setups compare — see our complete guide to business structures in Australia.
| Feature | Testamentary Trust | Family Trust (Discretionary) |
|---|---|---|
| When created | On the will-maker’s death | During the person’s lifetime |
| How funded | Assets from the deceased estate | Any assets transferred into the trust |
| Tax on minors | Adult marginal rates (including tax-free threshold) | Penalty rates under Division 6AA |
| Asset protection | Strong — assets are not owned personally by beneficiaries | Moderate — depends on structure |
| Probate required | Yes — estate must go through probate first | No — assets already held in trust |
| Control by creator | Set in the will — fixed at death | Active control during lifetime |
The critical difference is the tax treatment of minor beneficiaries. A family trust cannot offer the same tax efficiency for distributions to children under 18 — only a testamentary trust qualifies for adult marginal rates under section 102AG. Many families use both structures: a family trust for business and investment assets during their lifetime, and a testamentary trust in their will to protect and distribute their estate after death. These two structures are complementary, not alternatives.
For a deeper look at how family trusts work during your lifetime, read our guide on how to set up a family trust in Australia and how family trust distributions are taxed.
Who Should Consider a Testamentary Trust?
The straightforward answer is: anyone with an estate worth protecting. The following situations make a testamentary trust particularly valuable:
- Business owners with significant assets — property, business equity, or investments — who want to protect that wealth for the next generation
- Parents of minor children who want their children to receive income at tax-effective rates rather than at penalty rates
- Parents of children with disabilities who need ongoing, managed financial support without losing access to government entitlements — a protective testamentary trust can be structured specifically for this purpose
- People in blended families who want to ensure their assets reach their biological children rather than a new partner’s estate
- Anyone with a combined estate above $500,000 — the tax savings on distributions to minor beneficiaries alone can offset the cost of the structure within a few years
- People with concerns about a beneficiary’s financial responsibility — whether due to addiction, poor money management, or relationship instability — where a direct inheritance could be quickly dissipated
If you are a Melbourne business owner working with an accountant in Melbourne on your business structure, your estate plan should be part of the same conversation. What you build during your lifetime needs to be protected after it.
How to Set Up a Testamentary Trust
A testamentary trust must be established correctly to be effective. It is not a form you fill in — it requires coordinated legal and accounting input from the start.
Step 1 — Get professional legal and accounting advice. A testamentary trust involves both legal drafting (your will) and tax planning (the trust structure). Your solicitor and your accountant need to work together from the outset. A will drafted without tax input may miss critical opportunities; tax advice without legal implementation produces nothing.
Step 2 — Identify the assets to flow into the trust. Decide which assets will pass through your estate and therefore into the testamentary trust, and which are better held elsewhere. Superannuation, for example, passes outside the estate via a binding death benefit nomination and is not automatically covered by the trust.
Step 3 — Draft the trust deed as part of the will. Your solicitor drafts the testamentary trust provisions into your will. The deed specifies the terms — how the trustee operates, who the beneficiaries are, and any conditions or limitations you want to impose.
Step 4 — Name the trustee. The trustee is the person or entity responsible for managing the trust assets after your death. This is commonly a surviving spouse, an adult child, or a professional independent trustee. Always name a successor trustee in case your first choice cannot or will not act.
Step 5 — Define the beneficiary class. Specify who can benefit from the trust — typically your children, grandchildren, their spouses, and future descendants. A broad beneficiary class gives the trustee maximum flexibility to distribute income in the most tax-effective way.
Step 6 — Review the will and trust every three to five years. Your family circumstances, asset base, and the tax laws change. A testamentary trust set up in 2020 may need updating by 2025. Regular reviews with your accountant and solicitor ensure the structure remains optimal.
For more on structuring your affairs tax-efficiently, explore our tax planning services for Melbourne business owners.
Common Mistakes to Avoid
The most expensive estate planning mistake is not making one — it is making the wrong one and not realising until it is too late to correct.
Leaving children as direct beneficiaries in a simple will. This is the default for most Australians. It is also the most costly — income tax, creditor exposure, and relationship risk are all avoidable with the right structure in place.
Not nominating a successor trustee. If your named trustee dies, becomes incapacitated, or refuses to act, and you have no successor nominated, a court may need to appoint one. This delays administration, adds cost, and removes your control over who manages the trust.
Failing to account for superannuation. Superannuation does not form part of your estate and is not covered by your will. To direct your super to specific beneficiaries, you need a valid, current binding death benefit nomination (BDBN) with your fund. Without one, your super trustee has discretion over who receives your benefit — which may not align with your intentions. The ATO provides guidance on death benefit nominations for superannuation members.
Setting it up once and never reviewing it. Tax laws change. Your family changes. Your assets change. A testamentary trust drafted in isolation from your ongoing financial planning quickly becomes outdated. Treat it as a living part of your financial structure, not a set-and-forget document.
Frequently Asked Questions
Does a testamentary trust avoid probate?
No. A testamentary trust is created by your will, so the estate must still go through probate before assets can flow into the trust. Probate validates the will and grants the executor legal authority to deal with the estate. Only after probate is granted can the executor transfer assets into the testamentary trust. If avoiding probate is a priority, holding assets in a family trust or directing superannuation via a binding death benefit nomination during your lifetime achieves that goal — but the testamentary trust itself requires probate as a first step.
Can I have both a family trust and a testamentary trust?
Yes, and many Melbourne business owners do. A family trust holds and manages assets during your lifetime, while the testamentary trust in your will governs what happens to your estate after you die. The two structures serve different functions and complement each other well. Assets already held in a family trust at the time of your death do not automatically flow into the testamentary trust — only assets that form part of your personal estate at death will do so.
What happens to my SMSF — is it covered by my will?
No. Your self-managed superannuation fund (SMSF) is not covered by your will and does not automatically flow into a testamentary trust. Superannuation passes outside your estate and is governed by your SMSF’s trust deed and any binding death benefit nomination you have in place. To ensure your super reaches the beneficiaries you intend, you must have a valid, current BDBN with your fund. Speak to your accountant about reviewing your SMSF’s death benefit arrangements as part of your broader estate plan.
Who can be trustee of a testamentary trust?
Almost anyone you trust who has legal capacity to act. Commonly, the trustee is the surviving spouse, an adult child, or a professional trustee such as a solicitor or a trustee company. The trustee carries significant responsibility — managing investments, making distribution decisions, filing annual tax returns for the trust, and acting in the best interests of all beneficiaries. Choose someone with sound judgement and financial literacy, or consider a professional trustee where conflicts of interest between family members are a concern.
How much does it cost to set up a testamentary trust?
A will containing testamentary trust provisions typically costs between $1,500 and $3,500 in legal fees, depending on the complexity of your estate and the number of trusts involved. Once active, the trust requires annual tax returns and ongoing trustee management, which add to the administrative cost. However, the tax savings on distributions to minor beneficiaries alone can recover the setup cost within one to two years for a modest estate generating reasonable investment returns. The cost of not having one is almost always greater over time.
Can I change a testamentary trust after I set it up?
Yes — while you are alive. Because the testamentary trust exists within your will, you can amend or revoke it at any time by updating your will through a codicil or a new will entirely. Once you die, the trust terms are fixed and the trustee must act within the powers granted by the trust deed. This is why regular reviews during your lifetime are so important — changes in tax law, family structure, or your asset base may all require corresponding updates to the trust’s provisions.
General Advice Warning: The information provided in this article is general in nature and does not constitute personal financial, tax or legal advice. It has been prepared without taking into account your personal objectives, financial situation or needs. Before acting on this information, please consider its appropriateness to your circumstances and seek independent professional advice from a qualified accountant or tax advisor.
Frequently Asked Questions
What is a testamentary trust?
A testamentary trust is a trust set out in a person’s will that takes effect on their death. Rather than assets passing directly to beneficiaries, they are held in trust and managed by a trustee, providing tax benefits, asset protection and control over how the inheritance is distributed.
What are the tax benefits of a testamentary trust?
The main benefit is that income distributed to minor children from a testamentary trust is taxed at normal adult marginal rates, including the tax-free threshold, rather than the penalty rates that usually apply to minors. This can save families significant tax.
Who needs a testamentary trust?
They suit people with significant assets, young children, beneficiaries who may be vulnerable or face relationship or creditor risk, or anyone wanting to control how and when an inheritance is used. They are set up as part of estate planning with a lawyer and accountant.
How is a testamentary trust set up?
It is created by including the trust provisions in your will, so it only comes into existence when you die. Setting it up correctly requires careful estate planning advice to ensure the trust achieves your tax, protection and succession goals.
This article contains general advice only and does not take into account your specific circumstances. Please speak with a qualified accountant or tax adviser before making financial decisions.
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