CONSIDER A TESTAMENTARY TRUST

Do you wonder what will happen to your assets when you are gone - the property which you and your spouse have worked so hard to accumulate? Well, the old adage that you can’t take it with you still applies. However, you might have more say over what happens than you think.

Scenario 1.
You and your wife, Mary, have worked long and hard. Many years and 3 offspring later, you look back proudly and say it was worth it. You have a beautiful home, a unit at the Coast, investments, superannuation, your business is thriving, and finally you can afford to take some time off.

Your children are independent. Malcolm is a successful architect and has just joined a partnership. He is married to Annie. Katie is a registered nurse and has moved in with her partner, Jack, who is in between jobs. Andrew works for the public service and he and Jodie already have four young children. You and Mary have made Wills in similar terms, leaving your estate to one another. On the death of the survivor the estate is to pass to your three children in equal shares as this is only fair.

Scenario 2.
Some years on, you and Mary make your ‘celestial transition’ and the estate is about to be administered. However the
family stars are not in alignment:

- Malcolm’s latest work project has gone seriously wrong. A former client is suing for $4m damages, and his professional indemnity insurer is stalling. The stress has contributed to a breakdown of his marriage with Annie. He is worried that when his inheritance comes through, he will lose the lot if the court finds against him, and could face bankruptcy. Alternatively, his inheritance will be divided up with Annie as part of the matrimonial property in their Family Court proceedings.

- Katie has had enough of Jack’s bludging and abuse and has asked him to leave. Jack knows of Katie’s inheritance and
insists that as her de facto he has a right to part of it, and that he’s not going until Katie makes it worth his while.

- Andrew plans to use his inheritance to pay off the mortgage and invest in shares but is concerned about the extra income tax he will pay. Strategy

Revisit Scenario 1
You and Mary are back making your Wills. You inform your solicitor about your business, the family members, the family dynamics and your hopes for your children and grandchildren. Your solicitor advises setting up a Testamentary Trust.

Testamentary Trust
A trust essentially is established when a person (trustee) holds (the legal title to) property for the benefit of another person (beneficiary). A testamentary trust is simply a trust which is created by a Will. It comes into effect on the death of the Will maker. A Will can contain more than one testamentary trust eg a separate trust can be created and tailored to the needs of each primary beneficiary under the Will.

The Testamentary Trust comes in a number of forms. One of the most popular forms of Testamentary Trust is the Testamentary Discretionary Trust (TDT). The Testamentary Discretionary Trust (TDT) A TDT is essentially a Family Trust set in a Will. As with the Family Trust, the trustee can allocate income or capital to a beneficiary by referring to the particular circumstances which exist at the time, rather than being constrained by the Will maker’s predictions as to the future. This means that the exercise of discretion is involved.

The trustee must act responsibly however, and must always exercise their powers in accordance with the onerous trustee duties imposed by law eg to preserve trust property, and to act exclusively for the benefit of all beneficiaries. Why Use a TDT? The principal advantage of an appropriately drafted TDT is its flexibility. Remember that where assets are gifted by Will to a beneficiary subject to a testamentary trust, those assets are not owned by the beneficiary and do not form part of their estate until distributed to the beneficiary by the trustee. This is the essence of any trust.

These features combined make the TDT particularly useful as a facility to:

1. Protect inheritances from the Trustee in Bankruptcy, or from falling into the property pool divisible with a separated spouse or de facto spouse. (While such risks are imminent the trustee would make minimal distribution to the beleagued beneficiaries).

2. Access tax concessions - a TDT can achieve better tax outcomes than the traditional family trust, as children under 18 years can be assessed at the normal individual rate (the first $6,000 tax free and the balance at normal adult rates). Income tax can be minimized also by distributions being made to other beneficiaries on lower marginal tax rates.

3. Protect spendthrift beneficiaries eg gamblers or drug addicts; and
4. Protect beneficiaries who may be vulnerable to financial exploitation.

Disadvantages of a TDT
1. A TDT requires a greater degree of control compared to say, an absolute gift. Also, periodic recourse to accountants and lawyers is needed, and this involves a cost.

2. For tax purposes, the Will may provide that the primary beneficiary is also the trustee of the trust. This will enable the primary beneficiary to control the trust and still maintain the flexibility of trust distributions so to maximize income tax concessions. However, where the beneficiary in effect has power as trustee to distribute the whole of the income and/or capital to themselves, protection against creditors is diminished. As a precaution, there should always be at least two trustees and provision made for when they do not agree. Similarly, with family law and de facto law property division, if a beneficiary is seen to have sufficient control over the trust property, that trust property will be considered part of the property pool available for division. Ideally, the beneficiary should not be a trustee or appointor. The corollary is that this loss of control of the trust may make the TDT less attractive to a beneficiary.

3. Finding suitable co-trustees can be difficult and can cause further expense where a professional is appointed.

Conclusion
Testamentary Trusts are an important estate planning tool and worthy of consideration by Will makers as an effective way to protect assets and vulnerable beneficiaries and to access certain tax concessions.

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