The next decade will see $3.5 trillion1 worth of assets be passed down via the largest intergenerational wealth transfer Australia has ever seen. Alongside this unprecedented shift of wealth is the concerning fact that over a third of people aged over 50 either don’t have a Will2, or have not updated their Will in more than five years in order to reflect their current circumstances and familial relationships.
These two factors, combined with the reality that family structures are forever evolving, with over 12 per cent of families defined as blended (i.e. families with children that were made up of couples in their second marriage), means that the congruence of these three elements unfortunately culminates in an atmosphere that will be ripe for potential family conflicts over Wills and estates when the intergenerational wealth transfer begins.
However, one effective estate planning tool that can assist in the pre-emptive alleviation of potential conflict between beneficiaries when a loved one passes away is a Testamentary Trust.
What is a Testamentary Trust?
A Testamentary Trust is a legal arrangement that is often used to preserve assets for future generations. It comes into effect after you pass away with the objective of protecting the distribution of your assets for your chosen beneficiaries, in accordance with your wishes.
A Testamentary Trust is established within a Will and has an operational lifetime of up to 80 years from the date of the Testator’s (i.e. the individual who makes the Will) death.
In a Testamentary Trust, the assets pass to a Trustee who holds the assets for the benefit of the beneficiaries rather than directly to an individual, who is instead named as a Beneficiary of the Trust. The Trustee then effectively becomes the owner and manager of the deceased’s assets (which may include real estate, cash, shares and other investments). This means that the Trustee can invest and distribute assets and income to the individuals who are named as beneficiaries as per the terms and conditions outlined in the Testator’s Will.
Upon establishment of the Testamentary Trusts, the individual nominated as Appointer has ultimate control over this structure and has the authority to remove and replace the Trustee(s) and appoint additional Trustees.
Even though a Testamentary Trust is a powerful estate planning tool, it may not be suitable for everyone. Therefore, it is essential to not only evaluate the benefits and drawbacks of such a structure, but to also seek professional advice prior to making the decision to utilise one as part of your estate planning strategy.
When can a Testamentary Trust be beneficial?
A Testamentary Trust has many features that may be particularly beneficial where greater control over the management of assets and distribution of income is opportune, including but not limited to:
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- Blended families or families with young children as it allows for financial support whilst simultaneously protecting assets until they reach a specified age or adulthood.
- Situations where there are vulnerable beneficiaries such as those with a disability, with mental health issues, or those who lack financial maturity or who potentially face creditor risks.
What are the advantages and disadvantages of a Testamentary Trust?
When it comes to estate planning, a Testamentary Trust delivers a multitude of pros and cons as outlined below. However, it is essential to remember that before deciding whether such a Trust suits you, it is best to discuss your individual circumstances with a professional adviser who can help determine what is right for you.
Outlined below are the main advantages of a Testamentary Trust:
Asset Protection
A Testamentary Trust provides enhanced asset protection as the assets are held within the Trust and are not owned directly by any of the beneficiaries. Therefore, as the Trust holds the legal title to the assets held within the Trust, the assets are generally shielded from a myriad of risks including but not limited to:
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- Future Family Law Issues. A Testamentary Trust helps prevent the transfer of assets to a son-in-law or daughter-in-law upon a relationship breakdown as the assets are ring-fenced in the Trust and can be clearly identified and demarcated from other family assets.
- Financial Risk. As the assets are held by the Trustee (not the individuals) they are shielded from various risks including creditor risk due to debt, or bankruptcy proceedings should a beneficiary lodge or enter bankruptcy.
- Vulnerable Beneficiaries (e.g. young children, individuals who are intellectually disabled, temporarily incapacitated or have addiction issues). Here a Testamentary Trust is a malleable tool that works to protect the assets, provide a structure to help beneficiaries make financial decisions and simultaneously protect the beneficiaries from themselves or undue external influences that could result in the dissolution of an inheritance.
Tax Planning
A Testamentary Trust provides numerous tax benefits as it is ‘discretionary’ which means the Trustee can determine how the Trust assets are invested, as well as how income is distributed.
This enables the Trustee to make income distributions from the Trust in a tax-effective manner, for example: splitting the income to beneficiaries with lower tax thresholds to minimise tax. This is of particular benefit to families with minor children as income distributed to minors through via the Testamentary Trust is generally taxed at adult rates, which potentially reduces the overall tax burden on the estate.
In addition, there may also be other tax benefits such as Stamp Duty or Land Tax Concessions, however it is important to seek professional tax advice when looking to ascertain a comprehensive list of tax benefits.
Adaptable for Evolving Families
With ever-evolving families that can sometimes incorporate multiple generations, ex-spouses, de-facto partners, children of former spouses and more, a Testamentary Trust is a flexible tool that can address and manage the estate of a modern family.
In cases of previous marriages, or where the spouse re-marries, or for blended families, a Testamentary Trust can establish provisions pertaining to the diversion, protection and preservation of assets for partners, children and residual beneficiaries.
However, it is vital to note that if a Will does not correctly incorporate a Testamentary Trust, there may be complications between family members after the Testator’s death and the Testamentary Trust may fail.
Continuous Control
Further fortifying the asset protection benefit is the level of control that a Testamentary Trust provides.
With this structure, the Testator can specify terms and conditions that apply to the distribution of assets and income to beneficiaries, as well as request that the Trustee manage the assets professionally to ensure that they are invested and distributed in accordance with their wishes.
This level of control is particularly advantageous when the beneficiaries are vulnerable and could potentially lose their inheritance due to risks such as malicious external influences, mismanagement, or lack of financial awareness or astuteness.
Conversely, listed below are some of the disadvantages of a Testamentary Trust:
Management Costs
Establishing a Testamentary Trust involves legal and administrative expenses which surpass the cost of a standard Will. Subsequently there are ongoing costs which include, but are not limited to, annual tax returns, accounting fees, general administration costs and more.
No Direct Ownership
Since the assets held within a Testamentary Trust are not directly owned by the beneficiaries, they cannot be received as lump sum payments which may be preferred by beneficiaries especially in situations where it could help pay off a mortgage, wedding, university debt or other major life expense.
The assets of the Trust do not belong to the beneficiaries and depending on the terms of the Trust, they may have very little control over how the assets are managed or whether they obtain a benefit from the assets. Beneficiaries are also unable to elect to leave any of the trust assets under their own Will.
Succession Issues
The Testator must identify who will serve as Trustee of the Testamentary Trust in their Will. The Trustee controls the trust and has discretion to determine the future of the Trust and its assets, as well as its income distributions to beneficiaries. The Trustee is also subject to significant legal obligations and fiduciary duties which they owe to the beneficiaries.
Quite often issues arise where more than one family member shares the Trustee role, and each has differing opinions regarding how best to invest assets or distribute income to beneficiaries.
Another common issue is when a beneficiary challenges the terms of the Will due to issues around lack of access to capital or income. This can often be pre-emptively resolved if the Testator explains their intentions to their beneficiaries at the time they are preparing their Will.
Pension Eligibility
If a beneficiary is a pensioner, due diligence must be taken to ensure their pension eligibility is not jeopardised by their inheritance in the Testamentary Trust, as any inheritance may affect their income test.
Whilst there are many benefits to a Testamentary Trust, it is just one component of a comprehensive estate plan.
Other components which are equally as essential are superannuation arrangements, succession plans for any businesses, Powers of Attorney (for financial decisions), Enduring Guardianships (for health and lifestyle related decisions) and more.
Given not only the myriad of factors that need to be taken into account when planning for your future and beyond, but the complexity of Testamentary Trusts and estate planning overall, it is advisable to seek professional advice to ensure that you leave behind the lasting legacy you have worked so hard to create for your loved ones.
If you need any assistance, please contact the team at Antcliffe Scott.
Sources:
- The Productivity Committee
- Australian Census 2021
- Australian Seniors Report