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Inheritance Law 

Testamentary Trusts

How can testamentary trusts help my family?

 

What is a testamentary trust?

A testamentary trust is a trust established under a will, that an inheritance is gifted into for the benefit of a beneficiary (e.g. a spouse or child), instead of that inheritance going to the beneficiary personally.

 

How is this different from a 'normal' will, and what is the benefit?

Normally when a beneficiary receives an inheritance, immediately it is their property. If that person then is sued, or separates from their spouse, the inheritance is not separated from their personal assets. This can mean that an inheritance which was meant to provide for your child or spouse for many years, is lost.

 

What are the advantages of providing inheritances via testamentary trusts?

There are many advantages to testamentary trusts:

 

1. Income tax advantages – a testamentary trust allows a beneficiary to split the income from the inheritance between themselves and their children, and each person and child can take advantage of their marginal taxation rates and the tax free threshold.

 

Example

Mrs Smith earns $80,000 a year in income. She then inherits $600,000 from her father. She invests it in term deposits within a testamentary trust paying an average rate of interest of 6% giving the testamentary trust income of $36,000 per annum. She distributes the income to her 3 infant grandchildren. The tax implication of this is as follows:

 

Grandchild 1

Income              $12,000

Tax paid             $0

Income                                    $12,000

 

Grandchild 2

Income               $12,000

Tax paid              $0

Income                                    $12,000

 

Grandchild 3

Income               $12,000

Tax paid              $0

Income                                    $12,000

 

After tax                                $36,000

 

If Mrs Smith inherited it personally and invested the $600,000 in the same term deposit with interest of 6%, she would pay:

 

Mrs Smith

Income                                    $36,000

Tax paid (assuming 37%

marginal tax rate due

to other income earned)     $13,320

 

After tax                                $22,680

 

Note: funds cannot be invested in children's names as the income will be caught under the penalty rates of tax imposed on minors.

 

2.  Bankruptcy protection – assets of a properly drafted testamentary trust are not ordinarily available to the creditors of a bankrupt beneficiary. Therefore you can have peace of mind in providing any inheritance to a child or spouse who may be at risk of bankruptcy, and not be concerned that their inheritance will end up with their creditors. You may not think a child is a 'problem' child who is at risk, but if they are a professional in a high risk profession, such as a doctor or lawyer, they are at risk of litigation because of their profession.

3. Separating control of the asset from the enjoyment of the asset – People who have children vulnerable to the influence of others, or children with a gambling problem, drug addiction, or spendthrift nature, are able to use testamentary trusts to provide an inheritance for that child, whilst securing the inheritance away from the vulnerabilities of their child. This is because the parent can nominate a trusted person to be trustee of the inheritance on behalf of the child, and allow the trustee to supervise or control the access to the inheritance.

4. Education - grandparents can leave bequests via a testamentary trust for payment of tuition fees or other educational expenses for their grandchildren. This is a more tax effective method of providing for their education rather than leaving additional bequests to their own children for the purpose of educating the grandchildren.

5. Divorce of a child - assets held in a discretionary testamentary trust are not the assets of any one individual.  The inheritance assets can be clearly separated from the assets of your child’s marriage, and that separation maintained if the child separates from their spouse.  This separation will assist your child in coming to a property settlement with their former spouse and identifying their respective contributions to relationship property.  The inheritance may be considered as a resource of one of the children in a family law dispute, and in extreme examples, may be considered part of the relationship property, depending upon how it is treated.

 

6. Securing assets for your children whilst still providing for your spouse: Some families are more complex than others.  When we remarry later in life, and we have children separate from our spouse, we may want to use a structure which allows us to secure our children’s inheritance from us, whilst still providing for our spouse.  This might include for example, income from an investment portfolio, or a right to reside in the family home for life.  Testamentary trusts allow secure tailored solutions to complex succession needs.

 

Different types of testamentary trusts (TTs)

 

There are several types of testamentary trusts which are applied for specific purposes:

  • Fully discretionary, beneficiary controlled TTs: These allow your heir maximum control over their inheritance whilst still providing the benefits of asset protection and taxation flexibility.

  • Protective TTs: These are designed to protect a vulnerable beneficiary e.g. a person with a disability.  They include specific mechanisms for your child’s protection, which limits some flexibility but provides greater certainty.

  • Special disability trusts (SDTs):  SDTs are trusts designed to hold assets, particularly a main residence, for a person with a disability.  The advantage to them is that the assets (up to a threshold) are not counted in the means testing for that person’s disability pension.  They are also entitled to the main residence capital gains tax exemption.  SDTs are individually approved and must be drawn to the requirements of Centrelink.  An SDT can be established now, or in your will.  For more information on an SDT, contact us or see https://www.dss.gov.au/disability-and-carers/programs-services/special-disability-trusts/special-disability-trusts-questions-and-answers

  • Capital & Income TTs: These are highly sophisticated testamentary trusts which have different classes of discretionary beneficiaries, being:

    • beneficiaries entitled to income and capital of the trust; and

    • beneficiaries entitled to only income from the trust.  Typically these are considered where the willmaker wants to allow their children to distribute income of the trust e.g. dividends or interest or rent, to their spouses, but the willmaker wants the capital of the trust (i.e. the inheritance, and all accumulations and accretions to it) to be preserved for their bloodline. These allow a compromise between reserving the capital for descendants and taxation flexibility of being able to distribute income to a broader range of beneficiaries.

  • Accommodation Funds, Life Interests, rights of residence: There are a number of different options for using a TT for holding a residence for a beneficiary.  Moin & Associates are working on a new product which will be launched soon specifically for providing a home for your spouse for their life whilst reserving the capital for your children in the modern flexible structure of a testamentary trust. 

  • Inheritance Protection TT: This TT is designed to completely protect your child’s inheritance from their former spouse in the event they separate.  It is the ‘nuclear option’, and has some significant drawbacks which makes it appropriate in only limited circumstances.  Please contact us for more details.

 

The Moin Morris Schaefer Testamentary Trust difference

At Moin Morris Schaefer we invest significant time and effort to ensure that all of our estate planning tools, including our testamentary trusts, are up to date and incorporate the latest advancements in trust law and practice.  Our trusts have a modern flexible definition of income, accounting for the Bamford High Court decision, provide income characterisation and streaming powers to the trustee, and have modern succession of control provisions, have special provisions to provide optimum taxation outcomes when superannuation is passing to a beneficiary and allow for the main residence tax (e.g. capital gains tax, land tax) exemptions to apply, when appropriate.

 

We focus on providing estate planning tools which will be practical and useful to the end user – being firstly the willmaker, and then their beneficiaries.  We do not create trusts for the purpose of feeding commissions or income to advisors or other companies.  The trusts are first and foremost for the client.

 

Our trusts, subject always to your instructions, are designed for maximum flexibility to ensure that your beneficiaries are not ‘locked in’ to an antiquated structure after your death which costs them time and money.

 

FAQs

Are testamentary trusts always appropriate?

No.  There needs to be a certain level of assets (keeping in mind this can include superannuation and life insurance) to make the testamentary trust’s inherent advantages come into play.  Further, the beneficiaries need to be willing and able to use a testamentary trust.

The use of testamentary trusts, like all estate planning tools, needs to be justified and appropriate in the context of the willmaker’s specific wishes and circumstances.  We will not recommend a testamentary trust unless we consider that you and your family will benefit from it.

 

What are the ongoing costs of testamentary trusts?

There are no ongoing costs during the willmaker’s life because the trust is only established on their death.  Once set up, the testamentary trust will need to obtain a tax file number, and will need to lodge a tax return each year if it earns income.  Therefore there will be an accounting cost if you use an accountant.  The trust does not need to be audited and there are no regulatory fees. 

There are no ongoing legal costs with operating a testamentary trust.  That said, we recommend that all trusts, be they testamentary trusts, family trusts or SMSFs, ought to be reviewed once every 3-5 years as part of your estate planning process.

 

Can testamentary trusts prevent someone contesting my will?

No.  Testamentary trusts take effect after the administration of your estate.  Therefore any claims which are made against your estate are not reduced or defeated by the use of a testamentary trust.

 

Please contact us to discuss how you may address a risk that someone will make a claim against your estate.

 

If I have an ordinary testamentary trust will, will that completely protect my child’s inheritance if they separate from their spouse?

Not necessarily.  Whilst it is a strong advantage to separate your child’s inheritance from their relationship assets with a testamentary trust, the Family Court still retains power to make an order over the assets of that trust in certain circumstances, depending on a number of factors, including who controls the trust, who the beneficiaries are, and who has received benefits from the trust. 

The Inheritance Protection TT incorporates special features to protect your child’s inheritance completely from their former spouse in the event that they separate.  However the strategy has some significant drawbacks, and you ought to discuss with us how this works and whether it is appropriate for you before making any decisions. 

Greg Moin and Chelsea Schaefer are our family lawyers and will work together with our estate planning lawyers to provide a comprehensive solution for your needs.

Cameron Cowley

Special Counsel

Greg Moin

Principal Solicitor

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Richard Morris

Principal Solicitor

We stand by all of the legal information on our website.  However it is important to understand that it is not legal advice for you.  Advice must be tailored to your circumstances, and every client’s circumstances are unique.  If you try to apply the above information to your circumstances it may not lead to the outcome you seek.  We would be most happy to provide tailored advice for you suited to your circumstances.