What the new tax is
When a discretionary trust distributes income to a beneficiary, the trust may be required to pay a minimum 30% tax on that amount. Whoever receives the income is still taxed at their own marginal rate but receives a credit for the tax the trust has already paid. If their own rate is below 30%, there is no refund, and 30% becomes the floor. In plain English, the aim is to have trust income taxed a bit more like a wage. The measure is primarily aimed at the family trusts people set up during their lifetime to hold investments or run a business.
Why testamentary trusts are different
A testamentary trust does not exist during your lifetime. It is created by your will and only comes into existence after your death, and only if you have deliberately drafted your will to include one. For decades they have been the standard way to protect inherited wealth and manage it tax-effectively across generations. They shield an inheritance if a child hits a rough patch, a bankruptcy or a divorce, and they let income be shared with children and grandchildren at ordinary adult tax rates rather than the penalty rates that normally apply to minors.
How the exemption works
Rather than invent a new regime, Treasury has reached for the existing section 102AG excepted trust income rules, the same rules that have shielded children's inheritances from penalty tax for decades. The conditions are relatively straightforward. The trust must arise under a will, an intestacy or a court order relating to a deceased estate. The income must come from assets that came from the estate, or assets bought with those estate assets. And for testamentary trusts that come into existence on or after 1 July 2028, the income must ultimately be distributed to an individual or a tax-exempt entity such as a charity. The test is applied income by income, not trust by trust, so only income that misses the requirements is exposed, and a non-qualifying distribution does not contaminate the whole trust.
Two things worth checking
First, non-individual beneficiaries. For testamentary trusts established on or after 1 July 2028, income generally needs to be distributed to individuals or tax-exempt entities for the exemption to apply. Any testamentary trust that may distribute income to a company or another trust deserves a closer look, and some existing wills may need review. Second, keep the trust a genuine vehicle for estate assets and what they grow into. The exemption is designed for inherited wealth, not for sheltering the income of unrelated assets injected into the trust.
What this means for the average family
If you have a testamentary trust, or you are thinking about one, it will almost certainly keep doing what it was designed to do. The rules largely describe what a genuine testamentary trust already looks like: created under a will, holding estate assets, and distributing income to family members. If your will does not include a testamentary trust, this is a sensible moment to ask whether it should. A well-drafted one can be the difference between an inheritance that is exposed to a beneficiary's creditors, a divorce or unnecessary tax, and one that is shielded and passed on efficiently.
Where things stand
The exposure draft is open for consultation and the detail will evolve. The overall shape is now clear, and the direction is encouraging: the government has looked closely at discretionary trusts and, in doing so, confirmed testamentary trusts as one of the most effective ways to protect inherited wealth and pass it across generations.
What to do next
If you want to know whether your will already includes a testamentary trust, and whether it is drafted to keep the exemption, that is a short conversation. I prepare and review wills and testamentary trusts for families who want their wealth protected, tax minimised, and passed on cleanly.