Testamentary Discretionary Trusts

A testamentary discretionary trust is basically like your typical family discretionary trust, save that it is created by the will on the death of the will maker (and not at any time sooner). So the way it works is as follows. On the death of the will maker, provided there is a will in place, the executor (as nominated in the will) will assume full power and control over the estate of the deceased in order to administer it in accordance with the wishes expressed in the will.

If the will has incorporated testamentary discretionary trusts, then the executor will vest the residue of the deceased estate (“residue” meaning after all the debts and liabilities of the estate have been paid) into the hands of the trustee appointed to oversee the testamentary discretionary trust. If we are talking about a spouse testamentary discretionary trust, then naturally, the trustee to be appointed to oversee that trust will be the spouse.

The essential purpose of the testamentary discretionary trust is to separate the legal and beneficial ownership of the inheritance. So, whilst the trustee will have legal ownership of the trust assets, the primary beneficiary of the trust, say the spouse, will not have legal ownership or any proprietary interest in the trust assets, only the beneficial right to be considered for a distribution from the trust.

As the trustee and the primary beneficiary are one and the same person (i.e. the spouse), it is not hard to see how the trustee may wish to exercise their discretion each and every time for the benefit of themselves under the trust, as it is their trust at the end of the day.

But, as you will see further below, testamentary discretionary trusts can be incredibly effective tax minimisation and asset protection vehicles.

Testamentary discretionary trusts receive different tax treatment at law to other trusts.

Say you leave your whole estate in equal shares to your two (2) adult children directly in their personal names (as opposed to placing those shares in their respective testamentary discretionary trusts).

If your adult children are in the highest tax marginal rates (say 45% plus levies), then if your adult children were to receive $50,000 each in additional income for the year from the inheritances they received from your estate, the tax payable on the additional income of $50,000 for each beneficiary would be $22,500, or $45,000 on the combined income of $100,000.

This is no small amount of tax.

If on the other hand you distributed your whole estate in equal shares to testamentary discretionary trusts established for each of the adult children, the income of $50,000 earned by each of the adult children inside their respective testamentary discretionary trusts may instead, at the discretion of the trustee, be distributed to beneficiaries with the best tax marginal rates.

If the spouse and the two (2) minor children (i.e. under the age of 18 years) are not working for example, then despite them being treated as adults for tax purposes, they would be entitled to each claim the tax free threshold on any income they receive from the testamentary discretionary trust.

If the spouse and the (2) two minor children were to receive a one-third share of the $50,000 (i.e. $16,666.66 each, to cover say their welfare, school and tuition fees), then no tax would be payable on the $50,000, as each distribution would be within the tax free threshold.

This is a saving of $22,500 for that adult child’s family.

By contrast, if a similar distribution of unearned income was made to a minor beneficiary under your typical family discretionary trust during the life of the will maker, then this same tax treatment would not be applicable).

Additionally, there may be circumstances where assets held in a testamentary discretionary trust may not be taken into account when determining social security entitlements, like old age pension entitlements for example.

Testamentary discretionary trusts also offer great asset protection benefits.

For example, you may impose controls on how much of the trust income and capital may be distributed to the beneficiary over a set period of time.

The beneficiary may be a young adult, say in his or her twenties, who would be rather overwhelmed to suddenly be the recipient of hundreds of thousands, if not, millions of dollars. They could be a spendthrift, a high risk professional or involved in a high risk industry (like the police force, fire department or military), or they could be a bad business person or investor, involved in a precarious de facto or marriage relationship, or simply unlucky or unable to manage and conserve money.

In the circumstances, certain restrictions may be imposed on the trust such that the trustee may not distribute income (of say more than “x” amount per annum to each beneficiary) and must not distribute any of the capital of the trust at all unless and until the beneficiary has reached an age of “y” (which could be 30, 35, 40, 45 or at whatever age you feel the beneficiary can be trusted to have partial or full access to the trust capital, which may be the bulk of the inheritance).

The other concern that we often come across with our clients is the fear of not wanting to expose the inheritance to attack or challenge by a de facto partner or spouse of the beneficiary to whom the inheritance is left. The sad reality is that relationships these days are at risk of breaking down permanently and irretrievably, perhaps not straight after the will maker’s death, but at some time in the future is not all that inconceivable.

In those circumstances, if the beneficiary received a direct and fixed distribution from the deceased estate, without it being quarantined and placed into a testamentary discretionary trust, then that inheritance may well form part of the matrimonial asset pool and distributed between the parties as the Family Court saw fit.

The reality is that the former partner or spouse may walk away with a large chunk of that inheritance.

However, by placing the inheritance into a properly drafted testamentary discretionary trust, the beneficiary (on the occurrence of those specific events) will have no legal ownership or control over the trust assets, such that it will be very difficult for the Family Court to find any cause to justify those trust assets forming part of the divisible asset pool.

There are many other asset protection measures that a testamentary discretionary trust can achieve, and you should consult your lawyer about implementing a testamentary trust that accommodates your specific needs and requirements.

As holding assets in a testamentary discretionary trust vehicle is more complex than holding assets outright in your personal name, naturally, the yearly administration of the trust is slightly more complicated.

As the trustee, you will need to familiarise yourself with the provisions of the trust deed (which is a legal document that governs what you can and cannot do as the trustee).

You will likely work with your lawyers and accountants each year to ensure that the trust deed is up-to-date with any changes in the law, that your distributions of trust income and/or capital to beneficiaries comply with the trust deed and that your distributions are in fact made to one or more beneficiaries in the most tax efficient way.

Your accountancy fees for tax advice and the preparation of tax returns will likely also be higher.

However, these ongoing administrative fees do not arise until the testamentary discretionary trusts are actually established (which occurs following the death of the will maker).

Additionally, for example, if you vest your family home into a testamentary discretionary trust, as opposed to a beneficiary directly (such as the spouse, or surviving children, that intend to continue living in the family home), then this may have implications on the tax free capital gains concession that is typically applicable to principle places of residence on the sale of that house.

There may also be other disadvantages, potentially, depending on your specific facts and circumstances.

But, we often find that the advantages most usually outweigh any disadvantages.

If you can achieve greater asset protection and tax minimsation for your intended inheritances, then this usually is reason enough to implement testamentary discretionary trusts.

If you do not have any wills made, then you must have your wills done, which will incorporate testamentary discretionary trusts for either or both the spouse and the children.

If you already have simple wills in place, then your wills will need to be updated to incorporate the testamentary discretionary trusts.

The objective should be to do it once, and have it done properly, giving you the peace of mind you need.

Thereafter, it is usually recommend that you revisit your wills every 1 to 2 years to ensure that the wills reflect any changes to your circumstances and any changes to the law.

If you need legal advice or assistance in relation to the preparation of testamentary trust wills, please contact AdviiLaw today to speak to one of our experienced lawyers.

Contact us on 07 3088 7937 or email us at [email protected].

This commentary is of a general nature only, containing some general information for the reader. It is not intended to be legal advice, nor can it be relied upon as legal advice, as each case will depend upon its own specific facts, matters and circumstances.

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