Planning for what happens after you die is a key step in estate planning and shows love for your family. This is especially important if you have children or vulnerable adults depending on you financially. A testamentary trust might be the right tool to help you look after those you love.
What is a testamentary trust? It is an estate-planning tool designed to manage and protect your assets after your death, especially for beneficiaries such as children or vulnerable adults.
As the name suggests, a testamentary trust is made under a will and begins at the death of the testator (the will-maker). This tool allows you to provide financial support to someone without giving them direct control over the assets.
How is a testamentary trust made?
Your solicitor can draft your trust. Before speaking to your solicitor, you should think about what you want to include in the trust (the assets or capital), who you want to benefit from the trust (the beneficiaries), and who you can rely upon to carry out your wishes (the trustee or trustees).
A common arrangement for parents of young children is to place all assets (including property and superannuation) into a trust for their children’s benefit. In that scenario, the trustees might also be nominated as the children’s guardians.
Who should you choose as a trustee?
The trustee is the legal owner of the trust’s assets, so the most important thing is to ensure the trustee is reliable and honest. Having more than one trustee can be good insurance against fraud or carelessness.
In some cases, the size or contents of an estate may justify an expert trustee. A trustee can be a professional (such as an accountant or lawyer) or an organisation (such as the NSW Trustee and Guardian). However, a professional trustee does need to be paid out of the estate.
What are the advantages of a testamentary trust?
A testamentary trust allows a will-maker to control how their assets are distributed over many years, ensuring ongoing care for children, grandchildren, and even great-grandchildren. This arrangement offers several benefits, including asset protection and flexibility.
Protection
A testamentary trust can be very prescriptive. You can set out exactly how your money should be divided among the beneficiaries, when it is distributed, and even what it can be spent on. This can prevent the capital from being frittered away by beneficiaries with mental health conditions or addictions.
Because the trustee legally owns the trust’s assets, the funds are generally protected from outside claims against the beneficiaries. For instance, the trust is usually not vulnerable in family law litigation (i.e., the trust’s capital is unlikely to be split in a divorce). Similarly, the capital is generally insulated from bankruptcy, personal injury, and professional negligence claims.
Flexibility
You can choose to make your testamentary trust discretionary. In that case, the trustee has some discretion in distributing the trust’s income and capital. For instance, your trustee may distribute trust assets based on the different needs of each child over the years. This allows the trust to evolve as circumstances change.
Minimise Tax and Capital Gains
There are tax benefits from testamentary trusts, which you should discuss with your solicitor and accountant. In short, trustees may be able to distribute from a discretionary trust in tax-effective ways, including taking advantage of five-year averaging for capital gains losses. In addition, under a testamentary trust, minor children receive beneficiary tax rates for income from the trust.
Are there any disadvantages to a testamentary trust?
As with all forms of estate planning, a testamentary trust is not right for everyone.
The administration of a trust incurs costs each year the trust operates. This will include annual tax and auditing costs and could also include the trustee’s professional fees. For this reason, a discretionary trust is not usually the best option for smaller estates.
A testamentary trust can be challenged by those who wish to receive immediate access to their inheritance. Regardless of whether the claim succeeds, the process will incur additional legal fees for the estate and may cause family conflict. A testamentary trust always involves some degree of ongoing interaction between the trustee (s) and the beneficiary (ies). As with any family dynamic, this can be a source of tension and conflict.
Finally, income from a trust is used when calculating Centrelink income support benefits (although, currently, the assets of a trust are not used to determine eligibility under the asset test).
Conclusion
There are many benefits to using a testamentary trust to protect your loved ones. This form of estate planning allows you to protect your estate against outside claims and ensure that your wealth is used to benefit those you love. There are some disadvantages to choosing a testamentary trust, so it is important to speak to your wills solicitor and accountant before deciding whether this option is right for you.
This information is for general purposes only, and we recommend you obtain professional advice relevant to your circumstances.
If you or someone you know wants more information or needs help or advice, please get in touch with us on 0407 171 626 (Alicia) 0407 534 594 (Michelle) or email info@catronsimmons.com.au.