Do we need to rethink testamentary trusts after 2028?

Testamentary trusts have long been a popular feature of wills because they can offer both tax advantages and asset protection for the next generation. But with the proposed 30% minimum tax on discretionary trust distributions from 1 July 2028, testators may need to revisit whether the usual approach still achieves the outcomes they want for their family.

What’s being proposed?

As part of the 2026–27 Federal Budget, the Government announced that distributions from existing and new discretionary trusts are to be subject to a 30% minimum tax from 1 July 2028.

Under the proposal, the liability is effectively imposed at the trustee level, irrespective of the beneficiary’s marginal tax rate. Beneficiaries will be required to include distributions in their assessable income and will receive a non-refundable tax credit reflecting the tax paid by the trustee (except corporate beneficiaries).

The non-refundable nature of this credit is particularly significant. Where a beneficiary’s effective tax rate is below 30% part of the credit may be lost.

Does this apply to testamentary trusts?

Testators have often used testamentary trusts because they can offer a combination of tax effectiveness, asset protection and flexibility. They have been particularly attractive where a testator wants to protect an inheritance from relationship breakdowns or creditor claims, provide for beneficiaries with different needs over time (including those with disabilities or vulnerabilities), or benefit from favourable tax treatment for distributions to minors.

However, the Budget Papers indicate that testamentary trusts created after 12 May 2026 will fall within the scope of the new rules. An exclusion applies to “income from assets of discretionary testamentary trusts existing at announcement”. As these measures are not yet legislated, the precise scope of this exclusion remains uncertain.

The use of the phrase “assets of” rather than simply referring to testamentary trusts themselves raises an important interpretive issue. Although not elaborated on in the papers, this likely means the measures will apply at the asset level. As such income derived from an asset acquired post-budget would be subject to the minimum tax even where the testamentary trust is already in existence.

To the extent that the legislation reflects this, it may mean that trustees of existing testamentary trusts will lose the concessional tax treatment attached to pre-budget assets that are sold and reinvested, despite the fact that the total economic value of the trust’s assets has not changed. It may further be interpreted to mean that capital proceeds from the sale of pre-budget assets are subject to the new 30% tax.

Why this matters for estate planning

Given that the Commissioner and his delegates have spoken at length[1] about how Australia is in the midst of the largest intergenerational wealth transfer in its history,[2] it is perhaps unsurprising that discretionary testamentary trusts are not wholesale exempt from the proposed regime.

In contrast, the announced measures suggest that fixed trusts, fixed testamentary trusts, widely held trusts, complying superannuation funds, special disability trusts, deceased estates and charitable trusts may be excluded.

For testators, this may mean that the standard use of a discretionary testamentary trust in a will is no longer the obvious choice it once was. In particular:

• Fixed testamentary trusts may become more attractive – but exactly what constitutes a ‘fixed trust’ is a complex issue; and
• The continued role of discretionary trusts as the default planning vehicle may need to be reconsidered.

Estates currently under administration

With the potential of grandfathering provisions applying, executors need to understand the importance of timing.

A testamentary trust is often mistakenly thought to come into existence immediately upon the death of an individual who has made such provision in their will. This is incorrect. A testamentary trust does not typically come into existence until the administration of the deceased’s estate is completed and assets have been set aside on the terms of the trust. This distinction will become critical where estates were still under administration as at 12 May 2026.

Whether a testamentary trust has come into existence is a question of fact. We expect that, in borderline cases being administered as at 12 May 2026, this timing question may become critical. We expect that the ATO will dedicate substantial compliance resources towards the assessment of whether a deceased’s testamentary trust existed at the time of the budget being handed down given the favourable tax implications.

What to do now?

While we await exposure draft legislation, there are a number of practical steps worth considering:

• Review whether a testamentary trust still suits your family’s needs: If your priority is tax efficiency, the proposed changes may reduce the appeal of a discretionary testamentary trust. If your priority is asset protection, control or flexibility, it may still have an important role.
• Build flexibility into wills: Given the uncertainty and lack of draft legislation, it would be premature to remove testamentary trust options altogether. However, the ability to bypass discretionary testamentary trusts where appropriate should be included.
• Consider alternatives: Whether this is alternative vehicles or leveraging tax provisions with tax direct transfers.
• Record keeping: Trustees of discretionary testamentary trusts existing at the time of the budget should also be advised to maintain meticulous records of when the trust’s assets were acquired in order to protect the favourable tax treatment associated with pre-budget assets upon audit.

The proposed changes represent a significant shift in the taxation of trusts and may materially impact the long-standing advantages of discretionary testamentary trusts. Whilst an awareness is important, until the detail is settled, flexibility and mindful planning is key.

Want Wills & Estates updates delivered straight to your inbox? Click here to subscribe.

–

[1] Louise Clarke, Deputy Commissioner <https://www.ato.gov.au/businesses-and-organisations/business-bulletins-newsroom/spotlight-on-deputy-commissioner-louise-clarke>.

[2] Productivity Commission’s 2021 Report “Wealth Transfers and Their Economic Effects” < https://www.pc.gov.au/inquiries-and-research/wealth-transfers/>.