Testamentary trusts and the 2026 tax changes: why they deserve a fresh look

Estate planning rarely makes headlines, but a wave of tax change makes 2026 a good year to revisit how your will is structured. Some changes are already law: the next round of personal income tax cuts and the new Division 296 tax on large superannuation balances both take effect from 1 July 2026. Others are proposed but not yet law: the 12 May 2026 Federal Budget announced a major overhaul of capital gains tax and a new minimum tax on discretionary trusts. Together they change the backdrop against which families pass on wealth — and they have important, and in places uncertain, implications for one long-standing tool: the testamentary trust.

This article is general information only and is not legal or tax advice. The right structure depends on your circumstances, and the concessions and proposals described below have important conditions.

What is a testamentary trust?

A testamentary trust is a trust created by your will. It comes into existence only after you die, when some or all of your estate passes into the trust rather than directly to a beneficiary. A trustee — often a trusted family member, sometimes alongside a professional — manages the assets and decides, within the terms you set, how income and capital are shared among a class of beneficiaries, typically your spouse, children and grandchildren.

Because it is built into your will, a testamentary trust costs nothing to run while you are alive, and gives your family flexibility and protection after you are gone.

Benefit 1: A genuine tax advantage for children and grandchildren

This is the feature that has long set testamentary trusts apart.

Normally, income paid to a child under 18 from a family trust is taxed punitively. Under Division 6AA of the Income Tax Assessment Act 1936, a minor's unearned income is taxed at very high penalty rates once it exceeds a few hundred dollars — a deliberate discouragement of splitting income with children.

A testamentary trust is treated differently. Under section 102AG of the same Act, income a testamentary trust generates from estate assets is "excepted trust income," which means a minor beneficiary is taxed at ordinary adult marginal rates, including the tax-free threshold. In practice, each child or grandchild can receive around $18,200 of trust income tax-free each year — and a little more once the low income tax offset is taken into account — with the balance taxed at normal adult rates rather than penalty rates.

For a family with several grandchildren, that can mean tens of thousands of dollars of investment income each year taxed at low or zero rates, entirely legitimately. The 2026 and 2027 personal income tax cuts (the rate on income between $18,201 and $45,000 falls from 16% to 15% on 1 July 2026, then to 14% on 1 July 2027) sharpen this advantage.

Important: this reflects the law as it stands today. As explained below, the Government has proposed a new minimum tax on discretionary trusts that, if enacted, could significantly reduce this advantage for testamentary trusts established in the future.

Benefit 2: Flexible income splitting across the family

Because the trustee can decide each year who receives income, a testamentary trust lets a family direct income to whoever is taxed most favourably at the time — a non-working spouse, an adult child who is studying, or minor grandchildren. That flexibility is valuable in its own right and can adapt as family circumstances and tax rates change from year to year.

Benefit 3: Asset protection

Assets held in a properly structured testamentary trust do not belong outright to the beneficiary. That can offer meaningful protection:

• if a beneficiary later faces bankruptcy or business creditors; and

• in some circumstances, on the breakdown of a beneficiary's relationship.

For a child in a high-risk profession, or one whose personal circumstances are uncertain, inheriting through a trust rather than as a lump sum in their own name can make a real difference.

Benefit 4: Looking after vulnerable beneficiaries

A testamentary trust lets you provide for someone who cannot, or should not, manage a large inheritance on their own — a young person, a beneficiary living with a disability, or someone facing addiction or spendthrift tendencies — while keeping a trusted person in control of the money for as long as needed.

The superannuation angle: Division 296

From 1 July 2026, the new Division 296 tax applies an additional 15% tax to the earnings attributable to the part of a person's total superannuation balance above $3 million, with a further layer of tax above $10 million. Those thresholds will be indexed over time. The measure passed Parliament in March 2026 and is now law.

For Australians with large super balances, this changes the calculus. Superannuation is becoming a less tax-effective place to hold very large sums, and some people will choose to draw down their super or hold more wealth in their personal names. As more wealth sits outside super, more of it will ultimately pass through the estate — which is exactly where a testamentary trust does its work.

One word of caution. A testamentary trust does not avoid the tax that can apply when superannuation death benefits are paid to adult children who are not tax dependants. The interaction between superannuation, death benefits and testamentary trusts is genuinely complex, and it is one of the most important things to get right. Tailored advice is essential.

The proposed 2026 reforms: an important caveat for testamentary trusts

On 12 May 2026, the Federal Budget announced two proposed reforms that bear directly on testamentary trusts. Both were still before Parliament and not yet law at the time of writing, and their final shape will depend on the legislation as drafted.

Capital gains tax. The Government proposes to replace the longstanding 50% CGT discount for individuals, trusts and partnerships with a system of cost-base indexation and a minimum 30% tax rate on capital gains, from 1 July 2027. The change is intended to be prospective — gains that have already accrued before that date would keep the existing 50% discount — and the main residence exemption and the small business CGT concessions would remain. Testamentary trusts are not excluded from these CGT changes, so an estate trust that sells appreciated assets after the start date would come under the new rules.

A new minimum tax on discretionary trusts. The Government also proposes a 30% minimum tax on the taxable income of discretionary trusts from 1 July 2028, paid by the trustee, with beneficiaries receiving non-refundable credits for that tax. Because the credit is non-refundable, a beneficiary taxed below 30% — such as a child relying on the concession described in Benefit 1 — cannot recover the difference. In effect, this would place a 30% floor under trust income.

Are testamentary trusts excluded? Only in part, and the detail is critical. The proposed exclusion applies to testamentary trusts that were already in existence on 12 May 2026. Because a testamentary trust only comes into being on death, a trust created under the will of someone who is still living would generally not qualify — and would be caught from 1 July 2028. In other words, the income-splitting advantage that has long made testamentary trusts attractive may be substantially reduced for trusts established through new estate planning, even though it remains available under today's law and for trusts already operating. Some commentators have described the proposal as a backdoor "death tax" for this reason.

This is precisely the kind of area where timing and tailored advice matter. The measures are not yet law, the exclusions may change as the legislation is drafted, and there are real benefits of testamentary trusts — asset protection, control, and care for vulnerable beneficiaries — that do not depend on the tax concession at all.

Two further conditions under current law

Even putting the proposed reforms to one side, the existing tax concession is not automatic.

First, it is limited to estate assets. Since 1 July 2019, subsection 102AG(2AA) has confined the minor concession to income generated from assets of the deceased estate — or the proceeds of selling or investing those assets. You cannot "inject" unrelated assets, for example from a family company or a lifetime trust, into a testamentary trust to access the low rates. This integrity rule was introduced to stop precisely that practice.

Second, the trust must be properly drafted in your will. The concession depends on the trust meeting the requirements of the legislation, and the will needs to be structured with care. A poorly drafted clause can mean the benefits are lost.

Where to from here?

If your current will leaves everything directly to your beneficiaries, or if you hold a substantial superannuation balance, the 2026 changes — both those now in force and those still proposed — are a strong prompt to review your estate plan. A testamentary trust will not suit everyone, and the proposed trust tax reforms add genuine uncertainty to the tax side of the equation. But for many families these trusts still offer a valuable combination of flexibility, asset protection and control — and reviewing your plan now means you can act on the latest information and within any transition periods that ultimately apply.

We would be glad to talk through whether a testamentary trust is right for your circumstances, and how the proposed changes might affect you. Please get in touch to arrange a time.

This article is general information only, current as at June 2026, and does not take account of your personal circumstances. It is not legal or tax advice. Several of the measures discussed are proposed and not yet law, and may change. Please obtain advice tailored to your situation before acting.