Testamentary Trusts
Testamentary trusts or testamentary trusts that are established under a will are becoming more popular. A number of my clients have recently asked me about this type of estate planning. Here is a summary of the concept.
What is a Testamentary trust?
Rather than giving a beneficiary their inheritance “outright”, their entitlement is held in trust.
The trustee has the discretion to pay all or part of the funds held in the trust to the beneficiary or to the beneficiary’s dependents such as their spouse and children, in such amounts and at such times as the trustee decides.
These trusts are called testamentary trusts because separate trusts are established for each child and their entitlement can be distributed to their spouse and children.
Most Testamentary trusts give the beneficiaries the choice whether to take their inheritance or retain it in trust.
Tax Management
The primary motivation behind Testamentary trusts is normally for tax purposes.
If the beneficiary earns an income from their inheritance, for example, rent received from a property or interest received on an investment, the income would be taxed at the beneficiary’s marginal tax rate.
However, if the inheritance is retained in a Testamentary trust, the income that is earned can be split amongst the beneficiary’s blood-related family. This means that a spouse or child that is not working or otherwise not receiving an income, can receive an income from the Testamentary trust that would be taxed at a much lower marginal rate.
Asset Protection
Inheritances are generally seen as assets that can be claimed upon in property settlement proceedings under the Family Law Act and can be claimed by a trustee in bankruptcy (although superannuation and life insurance can be “exempted assets”).
Many Testamentary trusts contain provisions that prevent a beneficiary from acting as trustee if their relationship with their spouse breaks-down or they become insolvent. In these circumstances, a substitute trustee is appointed.
If a claim is made against the beneficiary, they can argue that they have no interest in the inheritance, other than to be considered by the trustee.
The theory is that a trustee in bankruptcy cannot claim the inheritance because the beneficiary does not have an identifiable share.
Similarly, if their relationship breaks down, the beneficiary can argue that they have no identifiable entitlement to the inheritance. This means that the funds may not form part of the beneficiary’s assets for identification within the matrimonial pool. However, the inheritance can still be taken into consideration as a “financial resource” and that the Family Court has broad powers to make orders against third parties.
Other Trusts
Most wills establish some kind of trust and the executor is normally appointed as trustee. These trusts may be only short-term, during the administration of the estate or may be used to hold a beneficiary’s entitlement until they attain a certain age.
Simple trusts can also be established to protect a vulnerable beneficiary from the influence of a third party or from themselves, if for example, they have a history of drug addiction or gambling.
Special disability trusts can also be established if necessary.
These types of trusts are less complex than Testamentary trusts and relatively easy to incorporate in a “simple” will.
Is a Testamentary trust right for you?
If you have significant assets you should consider Testamentary trusts.
If any of your children are relatively well-off and could benefit from the potential tax incentives, a Testamentary trust should be considered.
If there are other specific issues that a beneficiary may face, such as a breakdown of their relationship, insolvency, disability or potentially wasting their inheritance, the importance of Testamentary trusts and other special purpose trusts should not be underestimated.
Estate planning can be complex and it is important that you obtain the right advice. It may be that the costs involved in drafting a more complex will are worthwhile as a long-term investment for children’s financial security.
The above summary cannot be relied upon as legal advice.
If you would like Manny to address a particular legal issue, send your request to manny.wood@ticliblaxland.com.au or call him on (02) 6648 7487.
This article is intended to be for information and educational purposes only and cannot be relied upon as legal advice. The information may not apply to your circumstances or to your particular situation. If you need specific advice or you have any questions, we welcome you to contact us directly.
