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It’s a matter of (testamentary) trust

A will’s a will, right? Not so. Not all wills are created equal. Let’s talk about testamentary trust wills.

A testamentary trust will is an ideal vehicle for people who have significant assets or a complex family situation. It allows a willmaker to leave assets to a trust rather than leaving them to a beneficiary directly. A testamentary trust will can contain any number of trusts, and can be drafted to suit your needs and goals.

While a testamentary trust will is complex in a documentary sense, the will is simple to administer both for probate purposes and long term investment goals.

So what are the benefits of testamentary trusts?

Trusts are used in estate planning for a number of reasons including:

  • Providing asset security to beneficiaries who are exposed to creditors or business risks;
  • Providing a tax-free or tax-effective income to a surviving spouse, children or grandchildren;
  • Preventing irresponsible family members gaining ownership of (or disposing of) assets. The trust can instead provide them with a regular income; and
  • An appropriately drafted testamentary trust can provide some protection from family law claims.

Trusts provide asset security to beneficiaries because the trust is considered to be a separate legal entity to the beneficiary. Except in rare circumstances, creditors of the beneficiary (including a trustee in bankruptcy) will not be able to get at the assets contained in the trust.

Trusts provide tax-effective income by allowing beneficiaries to stream income to family members who are on lower tax rates than them such as spouses or children. One of the key advantages of testamentary trusts is that minor children can draw income from them at normal tax rates (with a normal tax-free threshold) rather than penalty tax rates. Let’s look at an example:

John is an apparently fit and healthy engineer when he suffers a fatal heart attack playing his usual Saturday afternoon game of tennis. His wife Joan is employed full-time on $90,000pa. She is left with three children aged 8, 10 and 11.

In Scenario 1, we’ll assume that John’s will leaves his estate ($700,000.00) to his wife Joan. In scenario 2, we’ll assume that John’s will leave the same amount to a testamentary trust that is used to pay for school fees, accommodation and other expenses :

 

Scenario 1

Scenario 2

Investment

 $700,000

 $700,000

Income (5% rate of return)

$35,000

$35,000

Income to?

Joan

3 children via trust

Tax payable per year

$12,950

$0

So who controls a testamentary trust?

Trusts created by a will can be controlled in any way you choose. Where trusts are created for asset protection or tax purposes, it is common for the intended beneficiary to have control of the trust.

Where trusts are intended to protect beneficiaries against themselves (eg. addicts or spendthrifts) or against family law claims it is more common to leave control of the trusts to other people such as siblings, trusted advisors or friends.

One important thing to consider is whether the trust should be mandatory. Often, it is best to give your beneficiaries the option of having a trust. That way, they will not be stuck in a trust structure if it is of no benefit to them.

Does one size fit all?

Your will needs to reflect your wishes, and testamentary trust wills are no different. Every testamentary trust will needs to be tailored to the purposes it is intended to achieve. To that end, here are some common types of testamentary trusts:

  • Capital Protected Trust Will. In this type of testamentary trust, the income from the trust can be distributed to beneficiaries but the assets (capital) remain untouched. This will is commonly used to ensure that wealth lasts beyond the life of the initial beneficiary so that the willmaker’s children, grandchildren and great grandchildren can benefit. A capital protected trust may provide for defined amounts of capital to be made available to the primary beneficiary (wife/child etc).
  • Fixed and Flexible Trust. This type of trust limits access to the assets of the trust by a beneficiary for that person’s lifetime. It can be useful in circumstances where beneficiaries are addicted to drugs, alcohol or gambling.
  • Staggered release. This type of trust staggers the release of income or capital from the trust to each of the beneficiaries. It is commonly used to give children access to trust funds in instalments as they age.
  • Special Disability Trusts. A special disability trust will creates a trust for the care and accommodation of a disabled beneficiary (usually the willmaker’s child). The income generated from this type of trust may be free from Centrelink means testing to protect the child’s disability pension and benefits, although some criteria do apply. The willmaker can provide for the distribution of the remaining balance of the trust on the death of the disabled person.

Hopefully this discussion has given you some useful information about testamentary trust wills.

If you’re not sure whether a testamentary trust will is for you, or if you have other questions in relations to wills or estate matters then please give us a call on (02) 6650 7000.

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