Trusts have long been recognised as having tax and asset protection advantages, particularly for people involved in business. Over time legislation and case law have whittled away many of the advantages. Regardless of this, trusts can still be an effective means of protecting your estate when you die.
Understandably, most people either aren’t concerned or don’t want to think about what happens when they die, but it is advisable to be prepared as it can affect your loved ones. A testamentary trust may make the transition easier for them at a difficult time.
So what is a testamentary trust?
A testamentary trust is created by your will. It distributes your estate to various trusts established by your will, rather than making direct gifts to your beneficiaries. Most wills typically have a trust component, for example your executor may hold your estate on trust while the administration of the estate takes place. A testamentary trust however, is a trust or trusts that take effect in the period after the executor has administered the estate.
These trusts may be discretionary or fixed. A discretionary trust allows the trustee the discretion to distribute income and/or capital to either named persons or a class of persons, for example grandchildren. A fixed trust is provides beneficiaries with an identified benefit for a fixed period. For example; the deceased’s spouse may reside in family home for life or until unable to reside.
A discretionary trust starts on a person’s death as it is created by your will on your death.
What are benefits of testamentary trusts?
Income can be split to take into account the different marginal tax rates of beneficiaries.
If beneficiaries are under 18 they gain the benefit of the tax free threshold for adults rather than the lower threshold for unearned income distributed to children. That is approximately $20,800 as opposed to $416.
A testamentary trust may provide capital gains tax and stamp duty flexibility and provide opportunities to reduce tax on your superannuation.
Income from a testamentary trust can be used for the education, maintenance and advancement of minors with no tax payable.
Protecting your assets
Leaving a bequest directly to a beneficiary means those funds may be subject to a claim by a creditor of the beneficiary. If the beneficiary is bankrupt the bequest could be claimed by the trustee to satisfy creditor claims. For example when you make your will, beneficiaries involved in business may be successful at the time, however circumstances can change. Having the beneficiaries’ assets in a testamentary trust also protects assets from a claim under a guarantee given by the beneficiary or their spouse.
Where a beneficiary dies, a bequest from your estate may be subject to claims from the deceased beneficiary’s family and dependants. Also, in some states the courts consider the size of the deceased’s estate when deciding family provision claims. This is not the case with testamentary trusts.
If a beneficiary separates from their spouse the assets in a testamentary trust are not subject to a claim by the spouse.
There are concerns that after you die your spouse may remarry and give some of your assets to a new family or children from a former relationship.
There are concerns that your spouse may put the assets you leave at risk in business ventures or with reckless spending.
High Risk beneficiaries
If a beneficiary is in a high risk profession or business, the assets can be protected from potential claims.
Disabled or beneficiaries with problems
Funds can be placed in a testamentary trust to provide support for a beneficiary who is incapable of managing their own affairs or is prone to making poor decisions. For example, children with gambling or drug issues. If the beneficiary is currently (or is likely to be) a social security beneficiary, consideration can be given to providing accommodation, care and some funds without impacting on their social security entitlements.
Keeping your assets within your family line
You want your assets to go through your children to your grandchildren. A testamentary trust can prevent assets being dissipated by parents through bad luck, bad management or adverse life events.
Giving assets over time
Where beneficiaries are young you may be concerned that, while they have immediate needs in their life such as a home and education, by receiving their bequest in a lump payment they may not use it wisely. By using a testamentary trust you could provide assets and income over time.
Sounds good but what are the disadvantages?
There is the ongoing cost of administering the trust, namely accounting and tax fees. For this reason it must be considered whether the income from the trust justifies incurring the management expense.
Potential disputes between trustees and beneficiaries that can alienate family members. Selecting the right people to be your trustees can be a problem.
As with all estates, a will establishing testamentary trusts can be challenged by eligible claimants including a surviving spouse or children who have “missed out” or are unhappy with their share or not getting payment straight away.
Invariably testamentary trusts involve complexity which can require professional advice. It will also more difficult for the person making the will to understand. It is important to note that a complex will can be attacked on the basis that the will-maker did not understand the financial arrangements he or she were making, thus professional advice and explanations are important.
Also, depending on the circumstances there may be duty and CGT implications.
Deciding whether a testamentary trust will is right for you is of course a matter of obtaining good advice and weighing up the pros and cons.
Can a testamentary trust will aid in business succession?
Testamentary trusts are often a useful tool in planning business succession. For example a person may want their business to be continued by the eldest child, but doing so leaves little else for the other children. In addition they may want income from the business to go to the support and maintenance of their spouse.
A testamentary trust will could be used to achieve a fair distribution, in this case supporting the spouse and allow the eldest son to run the business and buy out the other children over time.
If you have any questions about testamentary trust wills or would like to book an appointment to discuss estate planning or business succession, feel free to contact our team on email@example.com.