Episode 03: Changes to the taxation of Discretionary Trusts and Discretionary, Testamentary Trusts

Welcome to iWills Legal’s estate planning podcast. If you have a family trust, a self-managed super fund, or a will with a testamentary trust clause sitting quietly inside it, then a set of changes announced in this year’s Federal Budget may matter a great deal to you and to the people you intend to provide for. In May 2026, the Federal Budget, the Government proposed a new 30% minimum tax on the income of discretionary trusts due to commence from 1 July 2028.

Among the State Planners, the alarm bells rang loudest over what it might mean for discretionary testamentary trusts. The trusts created by your will long valued for their asset protection and for allowing income to be shared tax effectively among family members, including children, at ordinary adult tax rates.

The original budget caveat for testamentary trusts was unusually narrow and after considerable pushback from the legal and advice community and the Senate inquiry, the government amended its position mid-June.

To make sense of what has actually changed and what is now protected and what still hangs on legislation we have not seen, wills and estates accredited specialist Teresa Catalano walks us through the maze.

Teresa what exactly is a discretionary testamentary trust? And why have they traditionally been such a popular tool in estate planning here in Australia?

It’s a very important question, Rob, because to be honest, when these announcements were introduced by the government, it caused major confusion amongst the public because no one really knows or that term discretionary testamentary trust wasn’t sort of heavily used. A discretionary testamentary trust is akin to a typical family trust that someone might have set up during their lifetime except it’s set up under a person’s will and it only takes effect like any other part of their will when they’ve died.

And essentially the trustee of that trust, just like a family trust as I mentioned before, has discretion to determine where income and capital go from time to time to the class of beneficiaries. It can provide obviously tax planning benefits to those beneficiaries but also asset protection if it’s structured in a certain way.

The key difference to family trust based on the current legislation in any event is the concessional tax treatment of minors that I know we’re going to discuss a little bit later Rob, but that’s essentially what discretionary testamentary trusts are.

Let’s set the scene with the original budget announcement in May 26. What did the proposed 30% minimum tax on discretionary trusts actually involve and why did the estate planning community react so strongly when it when it came to discretionary trusts or discretionary testamentary trusts?

Yes, there was a lot of upheaval and uproar about it, to be honest. Certainly, in my career, I’ve never seen anything like this in terms of the amount of traction or retention in this estate planning space that those May 26 announcements drew. Basically, when those announcements were made, the primary focus, as you might have seen yourself Rob was more so on discretionary trusts which are the typical family trust that a lot of people in our community have but it was a little bit of a hidden or an underlying sort of not so public message about discretionary testamentary trusts which are the trusts and wills that as we said before so a little bit it didn’t sort of it wasn’t apparent or as obvious in that initial budget announcement but it sort of came out in days in the preceding days after that announcement.

And I think various professionals went to the budget papers directly and sought to understand what does this mean, especially in the estate planning space for discretionary testamentary trusts. And when people delved further into it, it was obvious that, apparent that they were only going to exclude fixed trusts from being subjected to that proposed new 30% income tax on discretionary trusts, but not discretionary trusts, including discretionary testamentary trusts.

And I myself saw a lot in the media from various ministers at the time sort of saying, well, trusts are excluded. It’s only discretionary trusts. It’s not fixed trust. But again, what does that mean? Most people wouldn’t understand, just to be perfectly frank, most people would not understand the distinction between a discretionary versus a fixed trust under a stage unless you’re a legal professional practicing in this space.

So most trusts in wills that are established are of a discretionary nature. So when we think about testamentary trust wills, generally speaking, they are discretionary testamentary trusts and not fixed trusts. Fixed trusts are just like an estate that’s held on trust for a particular beneficiary or even a minor until they’re of a certain age. But it’s clear that the assets and the income of that trust will vest in that one person, that or those couple of people, those beneficiaries. It’s not discretionary. There’s no class of beneficiaries of which the trustee can exercise discretion and can consider who to distribute to.

So back to your question, Rob, the reason why there was so much concern is because then in the estate planning space, it became apparent that the discretionary testamentary trust structures would absolutely be caught by this new proposed legislation.

Can you walk us through the problem with the original carve out as I understand it, it only protected trusts whose assets already existed at the time of the announcement. Which is a strange position for something created by a will.

Yes, absolutely. I mean, at the end of the day, even when the announcement was first made in May, there was no draft legislation tabled, there’s no law enacted, to be frank, and I know we’ll bounce back to this point later in our discussion today, but we really won’t know until there’s any form of at least draft legislation for us to really review and sort of dissect. But yes, I mean, it was really at the stage of those first announcements, there was no real carve outs at all on discretionary testamentary trusts. And it wasn’t clear itself that there were going to be, in terms of your family trust, any carve outs either. It was just very loosely, aside from fixed trusts, anything of a discretionary trust nature, we’re going to introduce that 30% tax for and yes, you know, we’ll have to look at this down the track. And yes, there may be carve outs, but that wasn’t tabled or detailed in any particular in the budget papers themselves at that point in time.

So we move forward on 18th of June, 2026. The government amended its position. In plain terms, what’s actually changed and how much better off are families now compared with where things stood on budget night?

Yes, look, I think that that was definitely a response to the media and the public’s reaction. As I said, there was a lot of upheaval, a lot of uproar, major confusion. And the government then released this consultation paper, in June, and has gone out to particularly professionals in this space saying, we want feedback, we need to understand how do we define these terms? If we are to introduce legislation, what is it going to look like?

So, there was more clarity that was given to this proposed 30% new income tax on trust. And just to be clear, it’s not a tax on capital, because I know that some clients have come to me on that particular question. It’s a tax on income. So it’s not going to affect the capital of the trust. It’s a tax on the income. So what became clearer as a result of those June or the June consultation paper that was released was that in terms of discretionary testamentary trust, they would now be excluded from this proposed new 30% tax as long as they were incorporated in the will for genuine testamentary purposes and I’ll get back to that later. But they also may only capture the assets of the estate. So once they’re set up, the person’s died, the trust is live and in effect, if you add other assets to that trust, which you can do even now under the current legislation, but you’re not going to get the same concessional tax treatment. And that would only apply to income from unrelated assets that was injected into that trust after budget night, after the 12th of May 26.

And then the other thing that has come out or the further clarification on discretionary testamentary trust is that from 1 July 28, right, they are proposing to now say that we will only exclude the new or discretionary testament to trust from being subjected to that new 30% income tax if the beneficiaries of that trust are confined to individuals and tax exempt entities such as charities. So not obviously having the usual more broader generic class you might find in Wills that those discretionary trusts, testimony trusts include companies and trusts. So they made that very clear and they again reinforced or reiterated the message that any fixed trust, such as special disability trusts, other fixed trusts that are created by Wills or your fixed trust now, like a unit trust for example, would be excluded from being subjected to that new tax.

The one thing that estate planning lawyers particularly were waiting to hear was, and this was clarified in that consultation paper in June, whether or not the concessional tax treatment of minors that testamentary discretionary trusts give us right now would be preserved. Because that was something that hadn’t been clarified. And as a result of this consultation paper, it now appears that it will be, which is a major tick for estate planning and for tax planning in terms of your succession planning.

But as a result of the release of this consultation paper, it’s also become clearer that it seems very likely that the new 30% tax will come into play as concerns your typical family discretionary trusts. Cool.

So we’ve got the revised exemption and there’s conditions. Where might people trip themselves up?

It’s interesting, people are confused and rightfully so. I am seeing a lot in the media and I’m reading a lot and if I didn’t practice in this space, I would be absolutely taking what these people are saying as being the truth and what’s now happening.

People are very confused. People are writing to us saying we need to do away with our family trust or we need to do away with our discretionary testamentary trust in our wills. We need to update our wills, we don’t want to trust. So these are the implications these proposed changes are having.

In our office we have formed quite a different view. And I know some of my estate planning colleagues would bear the same view. And that is let’s just wait.

We haven’t seen the draft legislation yet. Things are just moving. As you can see, there’s already been a lot of movement since the initial May budget announcement. So let’s wait and see. Is the legislation going to even be drafted? It seems likely it will be. But once it’s drafted, what does it say?

Will it get through? Will it even be passed in that form or any other form? Who knows? So once we get at least a draft version of any sort of proposed legislation, I guess we’re in a position to advise and we’ll do a follow up to this podcast no doubt, but to advise and guide our clients and the community as to what then needs to happen. But at the moment, we are saying sit tight, keep your family trusts, unless your accountant’s saying obviously for different tax unrelated legal reasons, but tax reasons not to keep that in play.

Keep your will, it was already suitable and if we advised to you to have a discretionary testament to trust, keep it in there. And let’s just watch your space. We will act quickly. We will definitely, and there’ll be a lot around this, I’m sure, from other people in the community as well, as to what needs to happen. But right now, it needs to stay. Now I think the other thing I’ve, even when the initial May announcements were made and we didn’t have that further clarity that we now have.

We advise people that these trusts do not only serve tax planning purposes, but they have a larger role to play in the intergenerational transfer of wealth, which can only be achieved via these trust structures. But also if you’re concerned or you’ve got vulnerable beneficiaries or those beneficiaries are at risk of going through a potential family law, relationship breakdown or being at risk of being sued by a credit or they’re not very good with their management of money, then trust structures are the only way to protect and to mitigate those risks.

So again, even if these tax things hypothetically came into play, why would we want to risk that? So it’s always going to be a balancing act and it needs to be looked at holistically in its entirety, working with your other accounting, financial advisors, et cetera. But it’s a bit more of a detailed case by case analysis type discussion as opposed to a blanket rule, yes, these laws have come into play, let’s say, let’s get rid of our trust.

It’s a really important distinction, isn’t it? Because I think people have looked at discretionary trust traditionally as a tax planning device. Whereas in estate planning, in fact, their more important purpose is to protect the capital of the estate.

Absolutely. It’s the only way that you can achieve that preservation of capital and to ensure that it’s succeeded down to the next generations, and also to the people you want it to be succeeded to and that it’s done in an asset protective manner.

Now I know in some of our earlier podcasts where we’ve discussed things around what forms part of your estate and what doesn’t and, and, mitigating the risk of will contests, for example, just to sort of recap on that point. Now, if you have assets in a family trust that sits outside of your will and therefore if there is an attack on your will, the assets in that family trust are going to be protected right so we don’t necessarily want to go off and get rid of our family trust even if the accountant for example says yes that makes sense to do that from a tax planning perspective, all because of these new tax laws coming in because it may actually impact the overall strategy in us trying to keep things outside of the estate environment.

So again, it requires careful thought and collaboration with each of your advisors.