If you want to pass wealth to your children in a way that’s protected from divorce, creditors, bad decisions and unnecessary tax, you’ll quickly run into two structures that sound similar but work very differently: the family trust and the testamentary trust. Both hold assets for the benefit of your family. Both can protect and tax-manage wealth. But they’re created at different times, treated differently by the tax system, and suited to different jobs — and after the 2026 Budget, the gap between them has widened dramatically.
This guide explains the real difference, which one actually protects your kids, and why the recent tax changes have made this question more important than it’s been in years.
Important: trusts sit at the intersection of law, tax and financial planning. This is general information — the trust deed or will itself must be drafted by a qualified solicitor. What follows is the planning context.
The Fundamental Difference: When the Trust Is Created
The single distinction that drives everything else is timing — when the trust comes into existence.
A family trust (technically a discretionary or inter vivos trust) is created during your lifetime. You set it up now, transfer assets into it, and a trustee manages them for a class of beneficiaries — typically you, your spouse, your children and other relatives. It’s a live, operating structure you use while you’re alive, giving you more control during life, commonly for running a business, holding investments, or splitting income among family members.
A testamentary trust is created by your will: the will maker sets the terms, and testamentary trusts work only after death, when the trust comes into existence. It doesn’t exist while you’re alive. On your death, assets from your estate flow into it, and a trustee manages them for your named beneficiaries — usually your spouse, children and grandchildren. It’s a succession structure: a way to control and protect how your wealth passes to the next generation. The appointed trustee can distribute assets under the trust terms.
That “during life” versus “on death” distinction is the key to which structure does what — and, crucially, to how each is now taxed.
How Each Provides Asset Protection for Your Children
Both structures share a powerful asset-protection feature: assets held in trust are owned by the trustee in that capacity, not by your child personally. Because your child doesn’t own the assets outright, those assets are generally much harder for others to reach. That protection covers your children against:
Relationship breakdown / divorce. An inheritance held in a properly structured trust is far harder for a child’s ex-partner to claim in a family law settlement than money sitting in the child’s own bank account.
Creditors and bankruptcy. If a child runs into financial trouble or business failure, trust assets are generally shielded from their creditors.
Poor decisions or vulnerability. For a child who is young, financially inexperienced, has an addiction, or is otherwise vulnerable, a trustee can control how and when money is released, and a testamentary trust can delay or stage fund releases for minor beneficiaries and other vulnerable beneficiaries, rather than handing over a large lump sum outright.
Here’s the important part: the testamentary trust is usually the better tool for protecting inherited wealth. The reason is simple. A family trust is a structure you control and use during your life — your children are just potential beneficiaries of it, and your own use of the trust exposes its assets to your risks (your business creditors, your circumstances). A testamentary trust, by contrast, is purpose-built to receive a child’s inheritance and ring-fence it for that child alone, at the moment of your death, with terms you set specifically for their protection. That gives it real asset protection advantages and can help protect assets from family law disputes, legal claims, and outside influences.
Put another way: a family trust protects assets while you’re using them; a testamentary trust protects assets as they pass to your kids. For the specific job of protecting inheritance for minor children, adult children, and broader family assets, the testamentary trust is generally the stronger fit.
The Tax Difference — And Why 2026 Changed Everything
This is where the two structures have sharply diverged.
The traditional family trust advantage was income splitting: because a discretionary trust is a flow-through vehicle, it could distribute income to whichever family member was on the lowest tax rate, often as part of tax planning aimed at reducing tax by distributing income to lower-rate family members. That was one of the main reasons families set them up.
The 2026 Budget targeted exactly that. The Government announced a 30% minimum tax on discretionary (family) trust income from 1 July 2028, specifically to curb income splitting. Distributing to a low-income spouse or adult child will no longer drop the tax rate below 30%, removing much of the family trust’s tax appeal. (The measure is announced but not yet legislated, with transitional rollover relief flagged — so the detail may shift.)
Testamentary trusts kept their biggest advantage. A testamentary discretionary trust can still be powerful, because a well-designed testamentary trust structure can deliver real tax advantages and broader tax benefits. A long-standing rule lets a testamentary trust distribute income to a minor (under 18) who is taxed at adult rates based on their marginal rate — including the tax-free threshold — rather than the penalty rates that normally apply to children’s unearned income. In practice, that can mean up to around $18,200 per child per year effectively tax-free. For a family with three children, that’s potentially over $54,000 a year of income distributed tax-free to the kids.
Critically, after initial uncertainty, the Government confirmed (in a June 2026 announcement) that income from testamentary trusts is intended to be exempt from the new 30% minimum tax, within certain parameters — recognising their genuine role in succession and asset protection rather than pure tax structuring. The concessional minor-rate treatment generally applies only to income from assets that originated in the deceased estate (a tracing rule tightened in 2019), so records matter. That means income earned on estate-sourced assets can be allocated in a tax-effective way, changing how beneficiaries pay tax and supporting tax savings.
The net effect: the 2026 changes reduce the family trust’s tax edge while largely preserving the testamentary trust’s — meaning a testamentary trust offers significant tax benefits as well as protection for many families passing on wealth. Because this area is still moving through consultation and legislation, current arrangements should be reviewed rather than assumed safe.
Family Trust vs Testamentary Trust at a Glance
Feature | Family (Discretionary) Trust | Testamentary Trust |
|---|---|---|
When created | During your lifetime | On your death, via your will |
Main purpose | Business, investment, income splitting while alive; generally a better fit for active lifetime planning than a simple will structure | Succession — protecting wealth passed to heirs and supporting future generations |
Minor beneficiary tax | Penalty rates on unearned income | Adult marginal rates (incl. tax-free threshold) on estate-sourced income |
2026 30% minimum tax (from 2028) | Applies (announced) | Intended to be exempt (announced) |
Protects a child's inheritance | Indirectly; exposed to your risks | Purpose-built for it |
Exists while you're alive | Yes | No |
Set up by | Solicitor/accountant, during life | Solicitor, under a simple Will or more tailored estate plan |
So Which One Actually Protects Your Kids?
For the specific goal of protecting your children’s inheritance, the testamentary trust is usually the answer for a person wanting more control over how a child’s inheritance is handled after death. It’s built for exactly that purpose: it activates on your death, ring-fences each child’s inheritance against divorce, creditors and poor decisions, lets a trustee manage money for young or vulnerable children, including helping with complex financial decisions and supporting a primary beneficiary under terms set in the will, and — thanks to the minor tax concession that survived the 2026 changes — does so with significant tax efficiency.
That doesn’t make family trusts useless. They remain valuable for operating a business, holding investments during your life, and broader asset protection while you’re alive, and can also be relevant where there are ongoing financial circumstances to manage — they’re a “now” tool. But as a pure “pass wealth to my kids, protected” vehicle, especially after the 2026 tax changes eroded their income-splitting advantage, the testamentary trust generally wins.
For many families the ideal answer isn’t either/or. A family trust may run the business and investments during life, while a testamentary trust in each parent’s will handles the protected transfer of wealth to the next generation, with estate-sourced underlying assets held separately from the child personally. And there’s a further wrinkle Australians often miss: superannuation (frequently one of the largest assets, with insurance attached) doesn’t automatically flow through your will, so directing super death benefits into a testamentary trust requires deliberate structuring.
How Money Path Can Help
Trusts are genuinely a powerful tool when used correctly, but they’re also easy to get wrong — the right structure depends on your assets, your family situation, your business, your tax position and your goals, and it should be legally sound given how the 2026 changes have shifted the ground under a lot of existing plans.
At Money Path, we help you make sense of it as part of your whole financial picture, including identifying the key benefits of each structure for your family. We work through what you’re actually trying to achieve — protecting a vulnerable child, guarding against divorce or creditors, minimising tax across generations, or all three — and help you understand which structure serves that goal. We coordinate with your estate planning lawyer and accountant, because tailored professional advice from an experienced estate planning lawyer is important so the legal drafting, the tax strategy and your financial plan all line up rather than working against each other. We factor in the pieces people forget, especially how your superannuation and any life insurance should interact with a testamentary trust. And we help you review existing family trust arrangements in light of the 2026 changes, so you’re not relying on a tax advantage that’s being legislated away.
The structures themselves are drafted by lawyers. Our job is to make sure the strategy behind them is right for your family — and that your wealth reaches your children the way you intend, protected and tax-effectively.
If you want to make sure your children’s inheritance is genuinely protected, talk to the team at Money Path about a review of your estate and trust strategy.
Frequently Asked Questions
What’s the difference between a family trust and a testamentary trust? A family (discretionary) trust is created during your lifetime and used for things like running a business, holding investments and splitting income among family members. A testamentary trust is created by your will and only comes into existence when you die, receiving assets from your estate to protect and manage for your beneficiaries. The key difference is timing — “during life” versus “on death” — which drives how each is taxed and what it’s best used for. In practice, a family trust is usually managed while you’re alive, while the testamentary trust starts only after the will maker dies and is then run by the appointed trustee.
Which trust is better for protecting my children’s inheritance? Generally a testamentary trust. It’s purpose-built to ring-fence a child’s inheritance against divorce, creditors, bankruptcy and poor decisions, and it lets a trustee manage money for young or vulnerable children, whether they are minor children or adult children, with access delayed until a beneficiary reaches preservation age if the will allows. A family trust protects assets while you’re using them during your life, but a testamentary trust is designed specifically to protect wealth as it passes to your kids — making it the stronger fit for that job.
How are minors taxed in a testamentary trust? Income distributed to a minor from a testamentary trust is generally taxed for minor beneficiaries at normal adult rates, including the tax-free threshold — not the penalty rates that usually apply to children’s unearned income. This can mean up to around $18,200 per child per year effectively tax-free, provided the income comes from assets that originated in the deceased estate. It’s a significant and, after the 2026 changes, largely preserved advantage.
Did the 2026 Budget change trust tax rules? Yes. The 2026 Budget announced a 30% minimum tax on discretionary (family) trust income from 1 July 2028, aimed at curbing income splitting. After initial uncertainty, the Government confirmed that testamentary trust income is intended to be exempt from this new tax, within certain parameters. The measures are announced but not yet legislated, so the detail may change and existing arrangements should be reviewed with advisers.
Does a family trust still make sense after the 2026 changes? For tax-driven income splitting, much of the advantage is being removed by the 30% minimum tax from 2028. But family trusts remain useful for operating a business, holding investments, and asset protection during your lifetime. Whether one still suits you depends on your circumstances — many families will need to review existing trusts and consider whether a different structure now works better.
Can I have both a family trust and a testamentary trust? Yes, and many families do. A family trust can run the business and investments during your life, while a testamentary trust in your will handles the protected, tax-effective transfer of wealth to your children when you die. They do different jobs at different times, and used together they can cover both lifetime needs and succession.
Do I need a lawyer or a financial adviser to set up a trust? Both, ideally working together. A testamentary trust is created through your will and a family trust through a trust deed — both must be drafted by a qualified solicitor. The strategy around them — which structure suits your goals, how beneficiaries and tax work, how the trust reflects your family’s financial circumstances, and how the drafting stays legally sound — is where a financial adviser and accountant add value. The best outcomes come from coordinating all three.
Does my superannuation go into my testamentary trust automatically? No. Superannuation generally doesn’t pass through your will automatically, so it won’t flow into a testamentary trust unless you deliberately structure it to — usually via a binding death benefit nomination directing your super to your estate. Because super is often one of your largest assets and may include life insurance, coordinating it with your testamentary trust is an important and commonly overlooked step.
This article is general information only and does not take into account your personal objectives, financial situation or needs, and is not legal or tax advice. Trust structures must be established by a qualified solicitor, and the 2026 trust tax measures are announced but not yet legislated and remain subject to change. Always seek personal legal, tax and financial advice before acting.
