Securing Your Legacy: How a Testamentary Trust Can Protect Your Children's Inheritance

As your children grow up, build careers, buy homes, start families, and create lives of their own, you might start thinking differently about your estate plan.

When you were younger, your focus may have been on providing for your children while they were still dependent on you.

Later in life, the question can become:

How can I pass on what I’ve worked hard to build in a way that gives my children and future generations the best possible opportunity?

One estate planning strategy worth understanding is a testamentary discretionary trust, often called a TDT.

A TDT can provide flexibility around how an inheritance is managed and distributed, and may provide additional protection for inherited assets.

It can be a powerful estate planning tool for families with significant assets, complex family circumstances, or children who may benefit from having their inheritance protected and managed over time.

What is a testamentary discretionary trust?

A testamentary discretionary trust is a trust established under your Will that comes into existence after your death.

Instead of your assets passing directly to your children, your Will can provide for assets to be held in a trust for the benefit of your chosen beneficiaries.

The trustee then has discretion, within the terms of the trust, about how and when trust assets and income are distributed.

Your children may be beneficiaries of the trust, as well as other family members, such as grandchildren. This means an inheritance does not necessarily have to be received as a lump sum directly into your child's name. That can make a significant difference where your goal is to preserve family wealth over the longer term.

Why would you use a testamentary trust?

There are several reasons a TDT may form part of an estate plan.

1. Protecting your child's inheritance

You have spent decades building your wealth. You may not want an inheritance to become vulnerable to risks affecting your child after you die.

Depending on the circumstances and how the trust is structured and operated, a TDT may provide an additional layer of protection against risks such as:

• relationship breakdown

• financial difficulties

• bankruptcy or creditor claims

• poor financial decision-making

• certain occupational risks

• vulnerability to financial exploitation.

Asset protection is never absolute, and the effectiveness of a trust depends on its terms, the circumstances, and how it is administered.

That is why the trust needs to be properly designed for your family's circumstances.

2. Giving your children flexibility

Your children's circumstances may be very different from each other.

One child might be earning a high income while another is studying, taking time out of work to raise children, or experiencing financial difficulties.

A discretionary trust can give the trustee flexibility to respond to those changing circumstances.

Rather than deciding today exactly what each child will need decades into the future, your estate plan can provide a framework that allows decisions to be made as circumstances change.

3. Protecting wealth for future generations

A TDT can also be used as part of an intergenerational wealth strategy.

Your children may benefit from the trust during their lifetime, while the trust can also potentially benefit future generations of your family.

That means your estate plan can be about more than simply deciding who receives your assets when you die.

It can be about creating a structure for how family wealth is managed and used over time.

What about tax?

Tax is another reason testamentary trusts can be considered as part of an estate plan.

There are special tax rules that apply to certain income generated by testamentary trusts, including rules concerning distributions to minors.

The tax treatment is technical and depends on the type and character of the income, the beneficiary receiving it, and the circumstances of the trust.

This is an area where your estate planning lawyer and accountant may need to work together.

A TDT should never be established simply because someone has heard that testamentary trusts are "tax effective".

The trust needs to make sense as part of your overall estate plan.

Can a testamentary trust protect an inheritance from a child's partner?

This is a common question we hear from parents.

If your child receives an inheritance personally, that inheritance may become intertwined with their financial and personal circumstances.

A testamentary trust can provide a different structure for holding and managing the inheritance.

Depending on the circumstances, this may provide additional protection if your child's relationship later breaks down.

It does not mean a TDT makes an inheritance completely immune from a Family Court property settlement or other legal claim. The circumstances and structure matter.

This is one of the reasons it is important to obtain tailored legal advice rather than relying on a standard trust clause or assuming that a trust automatically protects everything held within it.

What happens if your child has financial difficulties?

Imagine your adult child receives a significant inheritance directly. They might use it to buy a home, invest it, pay debts, start a business, or simply spend it. There is nothing inherently wrong with any of those choices.

But you may have a different vision for the wealth you've spent your lifetime building.

A testamentary trust can give your estate plan more flexibility around how inherited wealth is managed and distributed.

The trustee can make decisions based on the circumstances of the beneficiaries and the terms of your Will.

That can be particularly valuable where you have concerns about a child's financial vulnerability, business risks, relationship circumstances, or ability to manage a large inheritance.

Who controls the testamentary trust?

This is an important part of the planning process. Your Will needs to establish who will act as trustee and what powers and discretions the trustee will have.

Choosing the trustee is not a decision to make lightly. You are giving that person or entity responsibility for managing assets and making decisions about distributions for your family.

You might appoint one of your children, another trusted family member, or a professional trustee, depending on the circumstances. The right arrangement will depend on your family, your assets, your children's circumstances, and what you are trying to achieve.

What if you have more than one child?

A testamentary trust can be structured to provide flexibility between different beneficiaries. For example, your children may have very different financial circumstances when you die.

One might have young children and significant expenses. Another might have a high income and substantial assets of their own. Another might have a disability or other circumstances requiring additional support.

A discretionary trust can give the trustee the ability to respond to those differences, rather than requiring your estate to be divided according to a rigid formula.

Your estate plan can also include guidance for the trustee about your values, your intentions, and how you hope the trust will be managed.

This is where your Letter of Wishes can become particularly valuable.

What about grandchildren?

If intergenerational wealth transfer is important to you, you may want your estate plan to extend beyond your children.

A properly structured TDT can potentially allow multiple generations of your family to benefit. That might include funding education, assisting with housing, supporting a family member through difficult circumstances, or providing financial assistance at different stages of life.

The aim is not necessarily to control your family's money from beyond the grave.

It is about creating a structure that gives future generations opportunities while providing appropriate protection around the wealth you leave behind.

Is a testamentary trust right for everyone?

No. A testamentary discretionary trust adds complexity to an estate plan.

There are costs associated with establishing and administering the trust, and the trustee has ongoing responsibilities.

For some families, a straightforward Will may be the better option. For others, particularly families with substantial assets, multiple generations of beneficiaries, asset protection concerns, vulnerable beneficiaries, business interests, or complex family circumstances, a TDT may be worth considering.

The question isn't simply:

"Can I have a testamentary trust?"

The better question is:

"What structure will best achieve what I want for my family?"

Your estate plan is about more than what happens on the day you die

When you've spent decades building a home, investments, businesses, superannuation, and other assets, your estate plan can be an opportunity to think about the bigger picture.

Who do you want to benefit? What do you want that wealth to achieve? What risks do you want to protect against? Who do you trust to manage it? What happens if your children have very different circumstances? And what do you want your grandchildren and future generations to inherit, both financially and through the values you've lived by?

A testamentary discretionary trust can be one part of the answer.

It isn't suitable for every family, and it needs to be properly drafted and considered alongside the rest of your estate plan.

If you've spent a lifetime building wealth, it's worth taking the time to think about how you want that wealth to work for your family after you're gone.

If you're a parent with adult children and want to understand whether a testamentary discretionary trust could form part of your estate plan, get tailored legal advice about your circumstances and the options available to you.

Learn how a testamentary discretionary trust can protect your family's inheritance.

Thinking about including a testamentary discretionary trust in your Will?

Our free guide explains how testamentary discretionary trusts work, their potential benefits and limitations, and when they may be worth considering as part of your estate plan.