When you leave assets directly to your beneficiaries the assets immediately become available to any person who makes a claim against them. This includes their creditors if they are in financial difficulty, or an estranged spouse or other relatives if they are going through relationship troubles.
By setting up a testamentary trust, the assets benefit from a higher level of protection from such claims.
Each beneficiary will have the right to entirely by-pass the trust or only have some of the assets left in the trust and take some personally – if they wish.
2. Keeping your assets within your family line
When you leave all your assets directly to your spouse or partner, it is not ordinarily possible for you to ensure (“from the grave”) that your children are provided for – particularly if your spouse or partner remarries and has other children.
A testamentary trust can be used to give your spouse control over the annual income from the assets (and possibly some capital), but at the same time provide for the assets to ultimately pass to your children (and in turn your grandchildren, i.e. down your blood line).
3. Leaving assets to your kids at different stages over time
It is well accepted that giving a child a substantial sum of money at an early age is not wise. However, it is ordinarily difficult to prevent a child beneficiary getting their hands on an asset when they reach 18.
A testamentary trust can provide a high level of control and certainty as to when your children gain access to particular assets – and for what purpose.
It is possible to stagger the gifting of your assets over time (for example, when your children reach 21, 25, 30, etc), or to tie the release of your assets to particular events or uses. For example, it is possible to tie a gift to the purchase of a house, education or overseas travel.
4. Income flexibility – reduce as well as spread the burden of tax
When assets or money passes directly to one of your beneficiaries, all income earned from those assets or money becomes taxable income in the hands of that beneficiary.
If the assets or money passes to the trustee of a testamentary trust, the trustee can choose how to distribute that income from year to year. This enables the trustee to take advantage of the lower marginal rates of tax of one or more potential beneficiaries. (It provides the similar flexibility of a Family Discretionary Trust.)
5. Marginal rates of tax for kids – turn kids into adults for tax purposes
Income that is distributed to children under 18 from an ordinary trust is subject to the highest marginal tax rate of 45%, i.e. the child does not get the benefit of the tax-free threshold and the graduated marginal rates of tax.
However, children under 18 do qualify for these tax concessions on income that they receive from a testamentary trust.
This can potentially save a large amount of tax over the life of the testamentary trust, although care must be taken as to how the testamentary trust is administered, and how the income distributions to your children are recorded.
6. Capital gains tax and stamp duty flexibility
When you die and an asset passes directly to one of your beneficiaries, a transfer of all or part of that asset to another person will trigger CGT and stamp duty for that beneficiary. This is because the beneficiary has a “fixed interest” in the asset from the time of your death.
For example, if you have two children and each is given an equal share in two houses – and if they decide to take one house each – CGT and stamp duty will be triggered on 50% of each house. Leaving the assets in a testamentary trust can greatly reduce the cost of reconstructing entitlements under an Estate.
7. Reducing tax on your super
A testamentary trust can also deal with any super or life insurance proceeds payable on your death.
Without proper planning tax of up to 32% (usually 17%) may apply to the full value of your super pay out as a result of your death.
A testamentary trust will provide your Executors with the maximum flexibility to deal with any super paid to your Estate, so as to minimize taxes – as well as provide the other benefits set out above for your super money, i.e. wealth preservation, gradual succession, income flexibility, etc.
8. Reduced likelihood of claims against the Estate
When your assets are given “outright” to particular beneficiaries, it is relatively easy for a disgruntled beneficiary to prove they have not been adequately provided for.
However, a testamentary trust does not have a single beneficiary – but rather a range of “potential beneficiaries” – which can be structured to include a potentially disgruntled beneficiary. It then becomes more difficult for such a disgruntled beneficiary to bring a claim until the trust has been fully administered.
- Sam J Carbone
Barrister & Solicitor