For most people when they pass away, the majority of their estate sits within their home, their superannuation and their life insurance (which is paid to their superannuation). If you have kids or any complexity in your family, the question comes up, do I set up a Testamentary trust in my will, or are there other options.
In this blog I will contrast the use of a Discretionary Testamentary Trust (DTT) to the use of a Spousal or Child pension as a way to ensure your Superannuation and Life insurance (Super) are best used if you passed away.
Earnings, Payments and Distributions
Before jumping into this post, I want to define three key terms to reduce confusion.
When referring to ‘Earnings’ I am referring to the investment returns, yield, interest, dividends and realised capital gains on an investment. That is money the investment is making within the trust or income stream, not what is paid out of it.
When referring to ‘Payments’ I am referring to Pension Payments and Withdrawals from the Income Stream or Capital Withdrawals from the Testamentary Trust.
When referring to ‘Distributions’ I am referring to ‘Earnings’ that have to be released from a Discretionary Trust.
Testamentary Trust for Estate Planning
A Testamentary Trust is a structure created through your will and comes into effect upon your passing. This structure can be a powerful tool for managing assets, especially if you have minor children, family members with special needs, or beneficiaries you wish to protect from financial risks. These are set up through an Estate Planning Lawyer, under advice and consideration.
You can nominate your Superannuation Beneficiary Nomination to your Legal Personal Representative, which is your will - 'sending' the funds to your DTT. A properly drafted will includes provisions for your Superannuation to ensure it is allocated as tax effectively as possible, allowing your executor to set up the trust and the trustee to invest for the benefit of the beneficiary.
Key Benefits:
Control Over Asset Distribution: You can dictate how and when beneficiaries access the funds. This allows for "beyond-the-grave" planning to protect assets or ensure they are used responsibly over time.
Flexibility for Special Considerations: You can appoint trustees to manage the trust, providing flexibility to address situations such as guardianship of minor children or special needs beneficiaries.
Investment Flexibility: Testamentary trusts are not tied to superannuation products, offering a broader range of investment options, including direct property, shares, or even business assets. You may also be able to lend to beneficiaries, giving further flexibility for things such as purchasing a home, while providing some level of protection via the loan (this can be complex, please ask your Tax Agent and Lawyer about this)
Tax Advantages: Beneficiaries, especially minors, receive concessional tax treatment on trust income, taxed at adult tax rates instead of punitive minor rates. This is a huge advantage over investing in their own names as they access the Tax Free Threshold of around 20k.
Protection: Because the beneficiaries don’t own the assets, the trust does, this can keep the family assets separate from heir personal assets, protecting your estate from future relationships or business breakdowns.
Considerations:
Estate Asset: Unlike superannuation, assets directed into a testamentary trust form part of your estate. This means they could be subject to estate disputes or claims, which may complicate the administration process.
Costs and Complexity: A will that includes Testamentary trust provisions requires much more advice and input from an Estate Planning Lawyer, and as so it is more expensive than a basic will. In addition managing a testamentary trust once established on death, involves ongoing administrative work which, for smaller estates, may have costs may outweighing the benefits.
Trustee Discretion: Appointing a trustee you trust is essential, as they will have significant control over the administration and distribution of the trust's assets.
Earnings are taxed in the beneficiaries name: as per the Discretionary in the name, the DTT must distribute all of its earnings each financial year as Distributions. These are not taxed at the trust level but in the name of the beneficiary. As seen above this can be beneficial for Children, however if your spouse is still working they would pay tax at their marginal rate on any earnings in the trust. Withdrawals of capital are not taxed however.
Superannuation Income Streams for Estate Planning
You can also nominate your beneficiaries directly. The two most common nominations are directly to your Spouse or Children under 18 as these are both what is known as Tax and SiSa dependents, being able to receive the beneficiary, and not paying tax on any lump sum payments.
Once a lump sum payment is made however the money sits in that persons name, and any investment income they earn is taxable accordingly. Through using an Income Stream, you can use Superannuation to provide an ongoing income to support your loved ones on an ongoing basis, however the rules are slightly different for Spouses and Children under 18.
Spouse
When a spouse is the nominated beneficiary of your superannuation, they may have the option to receive the benefit in the form of a pension.
Key Benefits:
Lump Sum Flexibility: Your spouse can withdraw a portion of the superannuation as a lump sum before the remaining amount is commuted to a pension. This gives flexibility for immediate financial needs such as clearing a mortgage, while providing for ongoing income needs.
Tax-Free Earnings: Earnings on the pension are tax-free up to the Transfer Balance Cap, currently $1.9 million. This allows for a significant amount of assets to continue growing tax-free while providing an income stream.
Income Tax Concessions: The pension income is taxed at your spouse’s marginal tax rate, but they receive a 15% tax rebate.
Non-Estate Asset Protection: Superannuation is a non-estate asset, meaning it does not form part of your estate and cannot be challenged in estate disputes. A valid binding nomination ensures the superannuation is paid according to your wishes, offering additional protection for your surviving spouse.
Considerations:
Not All Super Funds Offer a Pension Option: Before planning around this, it’s crucial to confirm whether your superannuation fund allows for pensions to be paid to beneficiaries.
Product Restrictions: Once the pension is set up, your spouse cannot transfer it to another product or super fund.
Transfer Balance Cap: The amount commuted to a pension will count towards your spouse’s Transfer Balance Cap, limiting how much they can hold in tax-free pension phase.
Pension Minimums: Must pay out at least 4% as a payment per year.
Children Under 18
In cases where a child under 18 is the beneficiary, the superannuation can also be commuted into a pension under certain conditions.
Key Benefits:
Lump Sum Flexibility: Similar to a spousal pension, a portion of the superannuation can be withdrawn as a lump sum before the pension is set up.
Tax-Free Earnings: The pension’s earnings are tax-free up to the Transfer Balance Cap ($1.9 million), allowing the assets to grow without tax implications. This can be a substantial benefit as all capital gains and earnings on the investments are tax free!
Favourable Tax Rates: The pension income is taxed at adult tax rates, which are calculated similarly to a spousal pension (Marginal Tax Rate minus 15%), resulting in a reduced tax liability. If you drew the minimum 4% pension payment on a $1.9m Income Stream, you would pay approximately $3,700 tax on the $76,000 income in FY25.
Non-Estate Asset Protection: As with a spousal pension, superannuation does not form part of your estate and is protected from estate disputes, provided there’s a valid binding nomination.
Considerations:
Age Limitation: Once the child turns 25, the pension must be commuted, and the remaining balance paid out as a lump sum into the child’s name.
Fund Restrictions: Only certain super funds allow for this structure in their trust deed. You may have to switch super fund before setting up.
Product Restrictions: As with spousal pensions, the product cannot be switched after it’s set up.
Pension Minimums: Must pay out at least 4% as a payment per year.
Transfer Balance Cap: This uses the deceased transfer balance cap, and as such may have implications if there are other Pensions.
Summary Table
| DTT | Spouse Pension | Child Pension |
Tax On Earnings | Distributed as Income, taxed at Beneficiary Marginal Tax Rate | 0% | 0% |
Tax On Payments | Payments made as distributions are captured above, Capital withdrawals from trusts are non taxable. | Marginal Tax Rate + Medicare Levi – 15% offset. | Adult tax rates - Marginal Tax Rate + Medicare Levi – 15% offset. |
Timeframe | Specified in Trust deed | Until they pass away | Must be closed at age 25. |
Investment Flexibility | Open ended | Limited to the Products Menu* | Limited to the Products Menu* |
Value Cap | N/A | Earnings on amounts above Owners Transfer balance cap taxed at 15%.. | Earnings on amounts above Deceased Transfer balance cap taxed at 15% |
*Where you have an SMSF this could be much more flexible.
Conclusion
The key considerations to which is better for you fall on your priority and needs (in no order)
around
Capital Needs for your Family (such as paying off the mortgage, or buying a home)
Income Needs for your family and your spouses ongoing work needs
The age of your Children
Your family complexity including split families, children from prior marriages, disability or health concerns
Your broader asset base and how it may be used to meet the other needs.
Once you properly understand these aspects you can make a more informed decision on whether you prioritise tax savings (which generally speaking a Spousal or Child Pension will pay less tax) or control and flexibility, which the Discretionary Testamentary Trust provides.
I would always recommend you do not make this decision without the help of an Estate Planning Lawyer who can help you understand and balance these factors out.
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