Testamentary trusts and the minor beneficiary tax concession: still valuable after the 2019 narrowing

For Australian retirees doing estate planning — particularly those with grandchildren or minor children among the intended beneficiaries — a testamentary trust built into the will offers a tax planning advantage that no other structure can match: income from estate assets distributed to minor beneficiaries is taxed at adult marginal rates with the full tax-free threshold, rather than the punitive penalty rates that apply to minors under Division 6AA of the Income Tax Assessment Act 1936. The difference is dramatic. A grandchild who receives $20,000 of unearned income from an ordinary (inter vivos) family trust pays around $9,000 in tax under the Division 6AA penalty regime (45% on the whole amount above the small starting threshold); the same grandchild receiving the same income as excepted trust income from a properly structured testamentary trust pays little or no tax because the income falls within the adult tax-free threshold. Across multiple grandchildren and multiple years, the tax saving compounds into a major estate planning benefit. The 2019 amendments narrowed the concession in important ways, but for retirees with substantial income-producing assets and minor beneficiaries, the testamentary trust remains a core estate planning recommendation.

The Division 6AA penalty regime taxes "eligible income" (broadly, unearned investment income) of minors at very high rates under the rates set out in the Income Tax Rates Act 1986. For FY25-26: the first $416 of eligible income is tax-free; income from $417 to $1,307 is taxed at 66% on the amount over $416; and once eligible income reaches $1,308 or more, the whole amount is taxed at 45%. The policy intent is to prevent income-splitting through trusts that distribute income to children at low marginal rates — a strategy that was widespread before the introduction of Division 6AA. The collateral effect is that any distribution of trust income to a minor — beyond the small starting threshold — is taxed at effectively the highest possible rate, regardless of the family's overall tax position. For retirees with grandchildren and substantial investment portfolios, this means ordinary family trust distributions to grandchildren are economically pointless from a family tax perspective: the tax cost of the distribution offsets most of the benefit of getting the funds to the grandchildren.

The testamentary trust exception is set out in section 102AG(2)(a) of the ITAA 1936. The provision treats income derived by the trustee of a "trust estate that resulted from a will, codicil, an intestacy or an order of a court that varied or modified the provisions of a will or an intestacy" as excepted trust income when distributed to a minor beneficiary — meaning the income is taxed at the minor's ordinary adult marginal rates rather than at the Division 6AA penalty rates in s.102AE. The minor accesses the full tax-free threshold ($18,200 for FY25-26) and standard marginal tax bands. For each minor beneficiary in a testamentary trust, the trustee can distribute up to the tax-free threshold each year with no income tax payable. With four grandchildren as beneficiaries, the per-year tax-free distribution capacity exceeds $72,000 — across the trust's lifetime (often 20–30 years), the cumulative tax saving versus alternative structures runs into the hundreds of thousands of dollars.

The 2019 narrowing is the most important recent change to this concession. Before the amendments, some families used "stuffed" testamentary trusts — establishing a trust under a will, then injecting additional assets into the trust after the deceased's death (typically contributions from a surviving spouse or other family members). Income from those injected assets was being taxed at adult rates for minors, even though the underlying assets weren't from the deceased's estate. The Treasury Laws Amendment (2019 Measures No. 3) Act 2019, effective from 1 July 2019, narrowed s.102AG so that only income from qualifying assets receives the adult-rate treatment. Qualifying assets are broadly: assets transferred to the trust from the deceased's estate, and assets that wholly or substantially represent those original assets (for example, the proceeds of selling original estate assets, or accumulations of income from those assets). Assets injected into the trust after death by surviving family members are not qualifying assets — income from those assets is taxed at Division 6AA penalty rates for minors, even within a testamentary trust. The practical implication for estate planning: the testamentary trust must be funded from the estate, and surviving family members should not contribute their own assets to the trust in an attempt to extend the concession.

The structural design choices in the testamentary trust matter materially. A testamentary trust is typically a discretionary trust — the trustee has discretion over which beneficiaries (within a defined class) receive distributions each year. The discretion allows the trustee to distribute to minor beneficiaries up to the tax-free threshold first, then to adult beneficiaries with the lowest marginal rates, then to retain any remainder in the trust (taxed at the trustee level). The class of beneficiaries should be wide enough to enable genuine planning (children, grandchildren, future grandchildren, charities) without being so broad as to invite challenge. The trustee should be a person or combination of persons capable of managing the trust over decades — typically a family member trustee paired with a professional trustee or accountant. The trust deed should permit streaming of different income types (franked dividends to certain beneficiaries to use franking credits efficiently; capital gains separately) to optimise the distribution position year by year. Multiple testamentary trusts in a single will — one per child or branch of the family — allow customised distribution patterns and additional planning flexibility. A note of caution: distributions to minors must be genuine — the minor must be properly presently entitled and the funds applied for the minor's benefit — because the ATO's section 100A reimbursement agreement rules can apply where distributions to a low-rate beneficiary are not genuinely for that beneficiary.

The non-tax benefits of testamentary trusts are often as valuable as the tax concession. A beneficiary who experiences bankruptcy, business failure, or family law breakdown is generally better protected when their interest in the family estate is held via a discretionary testamentary trust than when assets are owned outright. A bankrupt beneficiary's interest in a discretionary testamentary trust is typically not available to their creditors because the beneficiary has only an expectancy (not an enforceable entitlement) until the trustee exercises discretion in their favour. In family law proceedings, the courts can sometimes look through a trust structure where the beneficiary has effective control, but discretionary testamentary trusts where the beneficiary is one of several potential recipients typically afford better protection than direct ownership. For families with adult beneficiaries in litigation-prone professions, marriage volatility, or business risk exposure, the asset protection benefit of a testamentary trust often justifies the structure regardless of the tax position.

What do worked planning examples show?

These two cases show how the testamentary trust strategy applies in practice. Illustrative only — not personal advice — using FY25-26 figures.

Case 1 — Walter and Eileen, both 71. Combined estate approximately $2.4M including the family home, an investment property, and a $1.1M share portfolio. Three adult children and seven grandchildren ranging in age from 4 to 16. On these facts, a testamentary trust strategy is compelling. Walter and Eileen's wills should establish a testamentary trust on the second death (or two trusts, one per will), with the share portfolio and investment property funding the trust. With seven grandchildren as beneficiaries, the trustee can distribute up to approximately $127,000 per year (7 × $18,200) tax-free across the grandchildren — using the adult tax-free threshold for each as excepted trust income. Income above that goes to the adult children at their marginal rates or is retained in the trust. Across the years until the youngest grandchild reaches majority, the cumulative tax saving versus a non-trust structure could easily exceed $400,000. Strategy point: don't include the family home in the trust — it doesn't generate income, so there's no income-tax benefit, and direct passing simplifies estate administration. Don't let surviving family members add their own assets to the trust — the qualifying asset rule means income from those assets doesn't access the concession.

Case 2 — Helen, 82, widowed for 6 years. Estate approximately $900,000, including the family home and a $400,000 term deposit and bond portfolio. Two adult children, one grandchild aged 8 (her son's daughter). On these facts, the analysis is more nuanced. The $400,000 income-producing portfolio generates approximately $16,000 a year — distributed to the grandchild via a testamentary trust as excepted trust income, that's within the tax-free threshold and so tax-free. Over the 10 years until the grandchild reaches 18, that's approximately $160,000 of tax-free distributions (assuming income reinvested or used for education). The setup cost of a will with testamentary trust provisions plus annual administration costs (trust tax returns, accounting) eat some of this benefit, but on these numbers the structure still pays for itself. Strategy: include testamentary trust provisions in Helen's will; brief the executor and proposed trustee on the strategy; consider naming the surviving adult children plus a professional as joint trustees.

For retirees with minor beneficiaries and substantial income-producing assets, the testamentary trust strategy remains one of the highest-value pieces of estate planning available — the 2019 narrowing reduced the scope for "stuffed" structures but left the core s.102AG(2)(a) concession intact for genuine inheritance situations. The advice work is to identify which clients benefit (those with minor beneficiaries and meaningful estate income), draft the will with testamentary trust provisions correctly (qualifying asset rule observed; beneficiary class drafted appropriately; trustee selection considered), and brief the executor and intended trustee so the strategy is actually implemented after death. For clients without minor beneficiaries or with small estates, testamentary trusts may not be cost-justified — be honest about the trade-off.

Sources

• classic.austlii.edu.au — S102ag
• classic.austlii.edu.au — S102ae
• Australian Taxation Office (ATO) — Income of minor children
• Federal Register of Legislation — C2019A00094
• MoneySmart (ASIC) — Wills