Testamentary Trusts- the star estate planning strategy!
As an estate planning lawyer I am passionate about educating my clients and the wider community about the benefits of including a Testamentary Trust in their will.
The reason is that they are a wonderful way to achieve what most of my clients want, (and what most of us want for ourselves when receiving an inheritance) as much protection as possible for our hard-earned wealth to benefit our loved ones for long term security. Protection especially against relationships and marriages that end, estate litigation claims, bankruptcy and insolvency events, and simply risky beneficiaries (spendthrifts, immature beneficiaries, and problematic drug, alcohol or gambling behaviours).
I see it as an affordable investment in ensuring that these risk events won’t erode the financial safety net, or leg-up, that you’ve worked so hard to leave. Starting at my rates for a single Testamentary Trust: in single Will from $600, and in a couple’s will from $800, it really is a case of money well spent to protect and save potentially tens of thousands later on.
And there are tax flexibilities and benefits too, especially where there are minor beneficiaries (under the age of 18).
Now you know why I love to use them, let’s have a look at what they are, and how they achieve the wonderful estate planning results that they do.
What is a Testamentary Trust?
It is a discretionary trust deed included in your will, very similar to a family trust that many readers may already have, the only difference being that whilst included in your Will, a Testamentary Trust does not become “alive” until the death of the will maker.
The Testamentary Trust will become the legal entity that receives an inheritance in place of say, a natural person.
For example, in my Will, instead of my beneficiaries being: “100% to my husband, and to my children in equal shares if he has predeceased me”; my beneficiary is simply: “100% to the Lucy Percy Testamentary Trust” and this is the entity that will inherit my estate, instead of the people named in the first example.
My husband and children will still benefit from the inheritance though, by being beneficiaries of the Testamentary Trust.
How does the asset protection work?
The trick to the asset protection is that they benefit from the inheritance without owing it in their names personally!
So when a personal risk event happens, such as my husband might re-marry after I am gone and then go through a divorce and property law settlement with his second wife, or he might die before her, my inheritance won’t be mixed with his personal assets now at risk of a family law settlement order, or an estate litigation claim. And then multiply that benefit x 3 for each of my children in the next generation.
We can’t forget the outstanding tax benefits of using a Testamentary Trust, especially where there are minor children or foreign beneficiaries.
Foreign beneficiaries ordinarily become entitled to an inheritance at the date of death of the will maker. And the tax consequences of them being non-tax residents (Australian) at this time can mean that there is significant additional tax to pay.
Where a Testamentary Trust receives the inheritance instead, it gives the trustee the flexibility to defer that tax event, and of when to make distributions to a beneficiary. There is likely to be tax savings in waiting for a foreign resident to return to Australia to satisfy the criteria to be an Australian resident for tax purposes at the time of any distribution.
For minor children, the ATO extends what is usually the adult tax-free threshold (approx. $22,000) to children under 18 each year.
Key points:
· The Testamentary Trust will be the legal owner of your inheritance instead of a natural person;
· The Testamentary Trust can only be created by being included in the Will prior to death (it’s either in there or not, there’s no second chances to add it after);
· It provides such great asset protection for the inheritance by separating ownership of the assets, from control of the assets, from benefit of the assets;
· There are additional tax flexibilities (by deferring the date of entitlement) and exemptions, as the ATO recognises for a Testamentary Trust to exist, someone close to the beneficiary has died.
I want one, what will my lawyer help with?
Your lawyer can help you tailor the right Testamentary Trust strategy depending on your asset position, the needs and relationships of the beneficiaries, quantum and type of inheritance assets. Some examples of variations might include:
· Making it optional or mandatory for a person to receive their inheritance through a Testamentary Trust or not;
· Whether one single Testamentary Trust should be shared by all beneficiaries (as in my personal example) or whether they should have one each;
· Choosing controllers (usually appointors and trustees) of the Testamentary Trust, and understanding what these roles mean to make an informed decision. For example, a beneficiary controlled Testamentary Trust might be the weaker position for asset protection, but a Testamentary Trust where a beneficiary has no control might be inappropriate and attract an estate litigation challenge for greater provision;
· The appropriateness of including or excluding foreign beneficiaries from the trust;
· Ensuring that there is always an Australian resident trustee at all times.
As I always say, the strategy should be bespoke for every client. It’s not a simple case of dropping the template into the will, because the success of the strategy needs to be underpinned by the relationships of everyone involved.
The output is only as good as the input
The positive legacy that using a Testamentary Trust can provide is enormous and can benefit multiple generations. However, the decisions of the trustees should not be made in a vacuum, and the quality of the results will only be as good as the quality of information that we leave them.
I encourage all of my clients to also create a Letter of Wishes to sit alongside their will and the Testamentary Trust to impart all of their values, wishes, and wisdom about how the assets in the Testamentary Trust might be controlled, invested, and distributed. For example, should the trustees use the money in the Testamentary Trust freely, or preserving a nest egg for the next generation. Maybe it’s ok to be used for education, but not to fund travel and lifestyle creep.
The star strategy: if you’re looking to ensure the intergenerational transfer of your wealth, in a way that is asset protected, tax efficient, and allows for your wisdom and values to be relevant from the grave, then a Testamentary Trust is for you.
If you’re not convinced, what’s stopping you from including an optional Testamentary Trust in your will and let your beneficiaries decide at the time to use it or bypass it?
Additional note: For clarity, I also want to add that as with all legal and financial strategies, there will be circumstances where using a Testamentary Trust is not appropriate. You should seek individual legal advice about what is best in your circumstances.