Budget 2026 – What’s Happening With Testamentary Trusts?

The May 2026 Federal Budget announced a radical change to the tax treatment of trusts, including new testamentary trusts. Given the importance of testamentary trusts in many people's estate planning, the proposed changes have brought significant uncertainty.

In the federal budget announced on 12 May 2026, one of the measures announced was a 30% minimum tax applied to discretionary trusts. If legislated, the effect of the change is that any income earned by a discretionary trust will be taxed in the hands of the trustee at a rate of 30%. The trust income can then be distributed between individual beneficiaries, with those beneficiaries receiving non-refundable credits for the tax paid by the trustee.

Do The Changes Apply To Testamentary Trusts?

As announced, the trusts captured by the change will include testamentary trusts that come into existence after budget night (that is, they will not apply to testamentary trusts where the testator had died and the testamentary trust had been established prior to 12 May 2026).

As testamentary trusts have been an important part of estate planning for many people, there is understandably some concern and confusion about the impact of the changes and whether testamentary trusts remain the appropriate mechanism for passing an inheritance to beneficiaries.

Do the changes mean I should get rid of the testamentary trusts in my will ASAP?

It is important not to make any rash decisions.

Firstly, it should be stressed that the budget announcements have not yet been legislated. Given the impact of the changes, particularly for those beneficiaries of deceased estates who are minors and/or on low incomes, it is likely that there will be substantial pressure on the government to look closely at extending the exemptions, such that a greater number of testamentary trusts are excluded from the changes. We have already seen some negative coverage of the testamentary trust portion of the changes, suggesting that they constitute a reintroduction of “death taxes”. Some news organisations (including the Sydney Morning Herald) have reported that the government may indeed be open to a reversal or amendment to the applicability of the budget measures to testamentary trusts.  It remains to be seen whether those reports are borne out in reality and if so the extent of the measures (or if testamentary trusts are excluded altogether).

In other words, it is not yet certain to what extent the minimum tax on trust changes will affect testamentary trusts.

Secondly, as set out in more detail below, there are many reasons why testamentary trusts will remain an appropriate estate planning tool for many people, and further appropriate provisions allowing someone to ‘opt out’ of a testamentary trust at the estate administration stage will provide your beneficiaries with flexibility to make the decision that is best for them at the time.

Do the changes mean testamentary trusts are no longer beneficial?

Not necessarily. Whilst the income splitting advantages of trusts including testamentary trusts may be substantially curtailed, for many people they will still be paying the same or less total tax if the inheritance passes into a testamentary trust structure, than if there were no trust and they had received the inheritance directly.

The precise difference in tax will depend upon:-

• The amount of income that the trust earns;
• The income that the “primary beneficiary” receives outside of any trust income;
• The relative tax rates of any other beneficiaries who would receive distributions from the testamentary trust.

For example, where a willmaker has an adult child who is intended to be the “primary beneficiary” of the testamentary trust, and that adult child already falls within the 37% marginal tax rate, the imposition of the minimum tax on the testamentary trust will not leave the child in a worse position, from a tax point of view, than if there were no trust at all and indeed will probably still result in less tax payable in total.

Critically, the other advantages of testamentary trusts remain – that is, significant asset protection advantages for beneficiaries at risk of bankruptcy, and also potentially for beneficiaries who experience a relationship breakdown and are facing a Family Law property settlement. Testamentary trusts will still usually provide much more robust protection in such scenarios, than if there were no testamentary trust structure.

In short, whilst some of the tax advantages of a testamentary trust will be reduced by the changes, there remain significant advantages to the testamentary trust structure.

How do I determine if the testamentary trust structure is right for my intended beneficiaries?

Usually, such a decision will be based on the beneficiary’s financial position as at the date of the will maker’s death, as well as the assets that would form part of the inheritance.

In other words, for many people, it will be something to be discussed between the adult beneficiary, the executors, and professionals such as your accountant and lawyer, following the will maker’s death, rather than right now.

For the time being, the most important thing will be to ensure that if your will provides for testamentary trusts, that the will also has an “opt-out” provision. This will often take the form of the executors (with the consent of the beneficiary) electing to bypass the testamentary trust structure for some or all of the inheritance, and to distribute it directly to the intended beneficiary rather than to the testamentary trust.

An opt-out provision of this sort ensures that everyone has maximum flexibility to decide what is right for them at the time of the relevant person’s death, rather than needing to lock it in at the time of making their will.

However, there are some circumstances (for example where the beneficiary is a spendthrift or suffers from an addiction or is otherwise in a vulnerable position) where the beneficiary is not included in the control of their testamentary trust and in these circumstances an opt out clause may not have been included.

It is a good idea to review your will with an experienced estate planning lawyer to consider whether there is a properly drafted “opt out” clause in the will.

Minor beneficiaries, spendthrifts and the easily influenced

There may be other considerations for willmakers who wish to protect their beneficiaries from themselves – that is, to protect the share of the estate for someone who may not be able to make effective decisions for themselves. In particular, the asset protection benefits of a testamentary trust will need to be weighed against the tax implications, particularly if the beneficiary is on a low income.

There may be some value in discussing a ‘fixed trust’, which as the name implies, provides a single beneficiary with a fixed entitlement. However, the asset protection of a fully discretionary testamentary trust may outweigh the tax advantages of the fixed trust.

Key Takeaways:

• If the budget announcements are fully legislated, there will be a minimum 30% on the income and capital gains of discretionary trusts including testamentary trusts;
• However, caution should be exercised in considering any changes to your estate planning, given the potential for there to be amendments to the government’s proposal between now and when it is put before parliament;
• Even if the changes are passed in their current form, the asset protection advantages of testamentary trusts will remain;
• For many beneficiaries, the changes will mean significantly reduced tax advantages but may not necessarily result in a tax disadvantage as compared to not having a testamentary trust and receiving the inheritance directly – this will depend upon the beneficiary’s existing tax rate, and the amount of income the inheritance is likely to generate;
• A critical component for a will containing testamentary trusts, is an “opt-out” provision, allowing the executors in conjunction with the beneficiary to choose not to use the testamentary trust structure, which will give the beneficiary greater flexibility to choose what is right for them, after the willmaker’s death, rather than trying to impose a solution now.

Further advice

The above is commentary of a general nature only, and should not be taken to constitute legal advice for your specific situation. If you would like specific advice, please do not hesitate to contact our estate planning team, who will be able to provide you with advice tailored to your specific circumstances, including whether any changes should be made to your existing will.

If you would like to make an appointment, please do not hesitate to contact us on (02) 9923 2321 or enquiries@somervillelegal.com.au.