What is a Special Disability Trust?
A Special Disability Trust (SDT) is a specific form of trust commonly used for beneficiaries who meet the statutory definition of “severe disability” under the Social Security Act 1991 (Cth) (‘Social Security Act’)1. It is designed to provide financial support for care, accommodation and long-term welfare of an eligible beneficiary, commonly designated as a “Principal Beneficiary” while preserving the beneficiary’ entitlement to social security benefits, including the disability support pension. SDTs are frequently employed in succession planning, as they allow assets to flow seamlessly from the deceased estate into a protected legal structure for the ongoing benefit of the disabled beneficiary beyond the lifetime of parents or carers and finally to the residuary beneficiaries in accordance with the wishes of the donor(s).
Tax advantages of an SDT
The taxation regime applicable to SDTs further enhances their financial utility. Once an SDT is validly established with an eligible Principal Beneficiary, the Principal Beneficiary is deemed to be presently entitled to the income of the trust during their lifetime2, and the trustee is assessed on the net income of the trust (including capital gains) at the Principal Beneficiary’s marginal tax rate3. This ensures that the trust’s income is taxed at Principal Beneficiary’s marginal tax rate rather than at the penalty rates otherwise assessed to the trustee.
Further, any capital gain from a transfer of a capital gains tax asset to a SDT or a trust that becomes a SDT as soon as practicable after the transfer, is disregarded. In many jurisdictions, stamp duty relief is also available for eligible transfers.
Estate Planning and Asset Protection Advantages
From an estate planning perspective, SDTs serve as a secure, transparent, and enduring mechanism for protecting the welfare of individuals with severe disabilities. The trust structure ensures that the assets are used solely for the reasonable care and accommodation for the principal beneficiary.
The SDT also enables continuity of financial support and care beyond the lifetime of parents or carers, providing families with peace of mind that their loved one’s future needs will be met. Furthermore, the terms of the trust may specify how residual assets are to be distributed upon the death of the principal beneficiary.
So what’s the catch?
Apart from the highly restricted eligibility criteria, limited ability on use of funds outside of care and accommodation needs of the Principal Beneficiary – i.e discretionary spending limited to $14,750 per annum (as at 1 July 2025) and stringent compliance rules to operate, we have also seen a common theme of certain uncertainties arising in relation to SDTs as to:
- what would happen to the funds in the SDT when the Principal Beneficiary has died;
- how any income derived by an SDT post Principal Beneficiary’s death is assessed, and
- who pays the tax and at what rate.
Consequences of Principal Beneficiary’s death
An SDT generally terminates upon the death of the principal beneficiary or when the trust’s funds are fully expended. At that point, the trust immediately ceases to qualify as a SDT under the Social Security Act.
Upon termination, the SDT ‘vests’, and the principles applicable to trust vesting should apply. ‘Vesting’ refers to the vesting of an interest rather than a position. An interest is regarded as having vested when:
- the beneficiaries or transferees have been ascertained4;
- all conditions precedent to the creation or transfer of the interest have been satisfied5; and
- in the case of a class gift, the quantum of each beneficiary’s share has been determined6.
Vesting of Special Disability Trusts
The vesting of an SDT does not automatically result in the termination of the trust or the creation of a new trust. Vesting merely signifies that the beneficiaries’ interests have become fixed, not that the trust has ceased to exist7. In Taxation Ruling TR 2018/6: Income tax – trust vesting – consequences of a trust vesting, the Commissioner takes the view that where a trustee continues to hold property for takers on vesting, the property is held on the same trust as existed pre-vesting, albeit the nature of the trust relationship changes. The trustee’s role transitions from a duty to properly consider whether to distribute the net income of the trust in accordance with the discretionary power of appointment, to a duty to hold the whole of the capital and income for the benefit of the relevant beneficiaries.
Vesting itself does not compel the immediate transfer of trust property, however, beneficiaries are entitled to call for the transfer of the trust assets as soon as practicable once their interests become fixed8.
Upon vesting, the SDT’s assets vest in accordance with the terms of the trust deed – i.e in the residual beneficiaries specified in the trust deed, in the proportions nominated by the donor(s). This nomination can generally be found in Schedule B of the model SDT deed as prescribed pursuant to the Social Security Act.
Assessment of income upon vesting
From a taxation perspective, upon vesting, the special tax concessions afforded for SDTs cease to apply, and any income derived by the trust post Principal Beneficiary’s death is taxed under general trust taxation rules in Division 6 of Income Tax Assessment Act 1936 (Cth) (‘ITAA36’). This means the assessment of any income derived post Principal Beneficiary’s death will depend on whether there is any present entitlement to the trust income.
By way of an example, if an SDT was established under a Will, and the donor has nominated the funds back to his or her estate upon the death of the Principal Beneficiary, it could be that the estate account is reopened, and the funds are distributed as part of the estate. As no beneficiary can be presently entitled to income of an estate until it has been fully administered – i.e the residual amount can be ascertained after all debts, expenses, and liabilities are satisfied9, the trustee is likely to be assessed either under section 99 or 99A of the ITAA36 depending on whether the Commissioner is of the opinion that it would be unreasonable that section 99A should apply10.
Once the residual beneficiaries acquire a vested interest in the remaining trust assets and income, the relevant beneficiary or the trustee, in case of residual beneficiaries who are non resident or under a legal disability, will be taxed on their respective share of the trust income at their individual marginal tax rate11.
Alternatively, if the donor has directed the funds in the SDT directly to named beneficiaries as opposed to the estate, the interests of such beneficiaries should become ‘vested’ upon Principal Beneficiary’s death and the trustee of the SDT should hold the funds on trust for those beneficiaries until the distributions are made and the trust is wound up. In this scenario, any trust income derived post vesting should be made presently entitled to the residual beneficiaries together with the trust fund in the proportions as nominated by the donor and the beneficiaries will be taxed on their respective share of the trust income at their individual marginal tax rates.
What does this mean for you?
What this means is that the uncertainties surrounding SDTs can be and should be managed and addressed right from the beginning at the planning stage so that there are no adverse tax consequences arising at the end.
As with any other trusts, the terms of the trust deed are paramount and, careful consideration should be given in nominating the residual/specified beneficiaries upon the end of the trust, and if an SDT is established under a Will, the terms of the Will should be in line with the terms of the SDT and ultimately your objectives.
How we can help
The Wills, Estate Planning and Structuring team at Moores is one of the largest in Australia with expertise in trusts and taxation. We can provide strategic advice tailored to your specific circumstances and work with you and your advisors through complex structuring, succession planning and tax issues in relation to special disability trusts from planning stage through to administration of same upon vesting.
Contact us
If you have any general queries regarding a Special Disability Trust, please do not hesitate to contact us.
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Disclaimer: This article provides general information only and is not intended to constitute legal advice. You should seek legal advice regarding the application of the law to your organisation.