Sophisticated Wills often include options for beneficiaries to receive their distribution from the estate via a ‘testamentary trust’. A testamentary trust is a trust created by a Will, where the distribution is held ‘on trust’ for the benefit of an intended beneficiary.
A clever way of constructing the testamentary trust is to form a discretionary testamentary trust, where the class of beneficiaries eligible to benefit under the trust includes the intended beneficiary and their relatives. The intended beneficiary usually has a substantial degree of control over the trust, whether through also being the trustee or appointor, or whether by having a veto power with respect to certain powers.
Constructed this way, testamentary trusts are the ultimate estate planning tool. They allow beneficiaries to take advantage of increased asset protection against creditors and / or other claimants, as well as taxation benefits. Testamentary trusts can also be used to enforce the deceased’s wishes and restrict a beneficiary’s ability to use the distributions the beneficiary received from the estate (i.e., protecting the beneficiary from himself).
One of the primary benefits of the testamentary trust is asset protection. For example, if Bob owes money to creditors and then receives a large distribution from his father’s estate, that distribution will be easily accessed by creditors. However, if Bob receives that money via a testamentary trust, the creditors will not be able to access that distribution, as that money is not owned by Bob but by the trust. To some degree, the testamentary trusts can also protect a beneficiary from losing its assets in the event of a marriage breakdown, although they may be considered a financial resource by the Family Court.
In terms of taxation benefits, the testamentary trust allows the trustee to enjoy certain taxation benefits. On a basic level, the flexibility of a discretionary trust allows a trustee to distribute and split the income of the trust with taxation considerations in mind: so, if Bob is earning a high salary and accordingly is subject to a high marginal tax rate, but his wife is unemployed, the trustee could distribute the trustee income to his wife and accordingly the income will be taxed at a lower rate.
In addition, whilst a normal discretionary trust is discouraged from distributing to minors (who usually have no taxable income) by having distributions to minors taxed at a flat rate of 46.5%, distributions from a testamentary trust to minors will be entitled to receive the usual taxation concessions of the tax-free threshold (up to $20,542) and graduated marginal rates of tax. A family with several children or grandchildren could avoid paying a lot of tax by distributing the income of the trust between the minors.
Finally, a testamentary trust could be used in a protective way to prevent a young, disabled, or irresponsible beneficiary from misusing the distribution. The formulation of the trust could accommodate for a range of restrictions on the use of funds. For example, Bob could be restricted from accessing the actual capital of the trust, only being able to use the income generated.
All in all, testamentary trusts are a useful instrument which should be seriously considered by anyone who is contemplating any kind of estate planning. The devil is in the detail and there is no one size fits all. We would be delighted to discuss your objectives in order to ensure that the benefits of these trusts are obtained by your loved ones.
Should you wish to discuss any aspects of the above and for any Wills and Estates, and Succession planning advice, please do not hesitate to contact:
Hugo Paul |
T: +61 2 8289 5805