Having worked hard over the years to accumulate wealth, most people want to ensure that their assets are available for future generations and not squandered by a frivolous beneficiary or accessible to an unintended recipient.
If you have acquired reasonable assets, have a blended family, or at-risk beneficiaries, then having a testamentary trust in your Will may significantly benefit those inheriting from your estate.
You may have heard of a testamentary trust in the context of financial or estate planning. But what is a testamentary trust, why do people have them and, more importantly, how can a testamentary trust benefit your family?
What is a testamentary trust?
A testamentary trust is a trust contained in a Will that comes into effect after the Will-maker (testator) dies. A trustee, pre-appointed in the Will by the testator, manages the trust which is usually established as a ‘discretionary trust’.
The discretionary nature of the trust means that the trustee may choose how and when the deceased’s assets are distributed to the beneficiaries. The beneficiaries or classes of beneficiaries are pre-determined in the Will and trust.
The flexibility and control in distributing assets to beneficiaries has many potential benefits and can ensure assets are retained for future generations. This flexibility and control is key to accessing the benefits available through a testamentary trust.
Favourable taxation treatment
Determining when and how income and assets are distributed from a testamentary discretionary trust can have a significant impact on how beneficiaries are taxed.
Income can be divided between beneficiaries to take account of their individual tax thresholds and financial circumstances.
For example, children under 18 years receiving distributions from the trust can generally access the adult tax-free threshold (presently $18,200), rather than being taxed at the (higher) flat rate which would normally apply to minors who receive ‘unearned income’. This can result in considerable tax savings with tax-free or minimally-taxed income distributions used to pay for children’s education, health and other expenses.
The flexibility to retain assets rather than transferring them at the time of the testator’s death can also be advantageous. The trustee’s discretion to choose the recipient of a major asset (such as real estate) and when that asset should be transferred can take into account Capital Gains Tax (CGT) issues and, with careful planning, avoid or postpone a liability for CGT. The same principle applies in determining if and when to sell an estate asset.
Protection of assets
A testamentary trust is ideal for protecting assets from going to those who were not intended to benefit from the estate, such as an ex-partner of the testator’s child or a creditor of a bankrupt beneficiary. Provided the trust is structured properly, in many cases assets will not be available to these third parties and can be preserved for those with whom a testator intended to share his or her wealth.
This protection is available because assets held in a testamentary trust are not ‘legally’ owned by any individual – in other words the beneficiaries have no ‘proprietary’ interest in the assets. Accordingly, the assets are not considered a resource of the beneficiary and may be exempt from a claim by an ex-partner in family law proceedings or a creditor of a bankrupt beneficiary.
By way of practical example, if a beneficiary was facing bankruptcy a trustee could refrain from making a distribution from the trust to that person, as doing so would only make the asset accessible to a creditor. By retaining the asset in trust, it is protected and does not constitute available property of the bankrupt beneficiary.
The protection described above also applies to ‘at risk’ or vulnerable beneficiaries such as those with disabilities, gambling or drug addictions. In these cases, distributions can be carefully monitored and managed.
Testamentary trusts for blended families
In some circumstances, a modest estate may also benefit from a testamentary trust. This may be so where the testator is part of a blended family, particularly if it is expected that estate assets are likely to increase over time.
The typical challenges faced by a testator within a blended family are the competing interests of past and present partners, biological children and step-children. Whilst it is likely that a testator wants to provide for the current partner, there may also be his or her own children from a previous relationship, step-children and / or children from the present relationship to consider.
The flexibility of a testamentary trust, enables the testator to include a set of provisions to apply if the current partner survives him or her, and an alternate set of provisions which will apply if the current partner does not survive the testator.
The trust can be drafted to provide immediately for the current partner (through a right of residence and income) whilst preserving assets for residual beneficiaries (such as the children). The objective here is that the testator’s assets can be immediately utilised by a first-generation beneficiary, whilst being preserved for future (residual) beneficiaries.
A testamentary trust provides flexibility in distributing your estate and enables wealth to pass to future generations. Beneficiaries may benefit from considerable tax savings and the trust can effectively safeguard assets from third party claims and protect at-risk beneficiaries.
A trust however, is a complex structure requiring effective management and administration. If you are considering having a testamentary trust in your Will, you should seek legal advice to ensure it is properly structured and the perceived benefits outweigh the likely costs of ongoing management.
The trustee will have a key role in the ongoing control of your estate assets. Care must be taken in appointing an appropriate person or entity. Although it is common to appoint the executor or a major beneficiary, this may not be in your or the intended beneficiary’s best interests. An independent trustee including a specially licensed trustee company may be desirable. A discussion with your lawyer setting out your family circumstances and objectives will assist in making the right choice.
If you or someone you know wants more information or needs help or advice, please contact us on (08) 8344 6422 or email firstname.lastname@example.org.