A Guide To Testamentary Trusts
By Lisa Ruggero-Salerno
Ultimately, a Testamentary Trust is one which is created by your Will and comes into effect upon your death. The rules governing the Trust are therefore established by you in the terms of your Will. This type of Trust provides greater control over the distribution and use of assets to Beneficiaries to enable that each Beneficiary’s inheritance is protected and preserved in some way from wastage and dissipation.
The Two Types of Testamentary Trusts
Under a Discretionary Testamentary Trust, the Beneficiary is generally also the Trustee of their own Trust. However, a third party can be appointed as the Trustee in substitution of, or in addition to the Beneficiary such as where the Beneficiary is facing bankruptcy, matrimonial problems, incapacity, and disability or has limited capacity to manage their finances. It may be prudent to appoint siblings to each other’s trusts. This is something that you can consider.
Under a Protective Testamentary Trust, the terms of the trust will only allow the Beneficiary to obtain an income stream from the Trust and any access to the capital assets is limited by the terms of the Trust. This allows you to pre-determine some degree of control or influence over the way the assets can be used by your Beneficiaries. This type of trust is often used where a Beneficiary is unlikely to be able to manage their financial affairs and where you wish to maximise the chances that assets will survive the Beneficiary for the benefit of a subsequent generation.
Who Should Be Appointed as the Trustee?
Ultimately, it is the Trustee who is afforded absolute control over the trust assets and it is therefore imperative that you select a Trustee who you know and trust to act in the best interests of your intended Beneficiaries. Anyone you desire, including the Executors of your Will, your spouse or partner, your children or a special purpose company may be appointed as the Trustee.
Suitability of Testamentary Trusts
Testamentary Trusts are often used in the following circumstances:
You wish to provide for one or more Beneficiaries who are children or someone who is temporarily or permanently incapacitated or disabled.
You are concerned that one or more of your preferred Beneficiaries is unlikely to be able to manage their own financial affairs.
You wish to ensure the trust asset survives all the Beneficiaries for the benefit of a future generation.
You wish to maintain some control and influence over the use and access of the trust assets by one or more of the Beneficiaries.
You are concerned that one or more of the Beneficiaries may have marital problems in the future.
Advantages of Incorporating Testamentary Trusts
There may be considerable income tax advantages to follow from the use of a Testamentary Trust. We are not Accountants and you should speak to your Accountant however, we offer general advice that it may be that any income received by minor beneficiaries (from a Family Trust or otherwise) is subject to penalty tax rates if their income exceeds the going threshold rate. However income distributed to children under Testamentary Trust may be taxed at the adult marginal rate rather than the penalty rates normally imposed. Again, you should consult your Accountant in relation to proceeding along this line.
Family Law Proceedings
Assets held in a Testamentary Trust where the Beneficiary is not also the Trustee as well as beneficiary, may be protected against any litigation by your children’s spouses and your partner’s spouse (should he or she re-partner after your death). It is important to note while such an asset cannot be subject to a Family Court Order, it may still be viewed by the Court as a financial resource of that Beneficiary and may have an impact upon the terms of any Order.
Under a normal Will, if a Beneficiary is insolvent or an undischarged bankrupt at the time of distribution, it is likely that their gift will end up in the hands of third party creditors. This situation can be avoided through the use of a Discretionary Testamentary Trust, as the Beneficiary will not be taken to have actual entitlement to the gift until the Trustee so determines, accordingly, the asset can be retained within the family or by the Trustee, free of any creditor’s claims while the Beneficiary is experiencing financial hardship.
Incapacitated or Disabled Beneficiaries
Testamentary Trusts are particularly useful where there is a Beneficiary who is incapacitated or disabled. You could leave a portion of your estate for that person’s benefit by appointing them as Primary Beneficiary (but not also as Trustee). Either a trusted family member, professional adviser or a company could then be named as the Trustee who has effective control over the access and use of the asset by the Beneficiary. This prevents unscrupulous persons from taking advantage of a disabled Beneficiary and avoids the needs for the engagement of an external agency to manage a portion of your estate. This type of structure may also be useful when the Beneficiary is not in a position to responsibly manage their inheritance due to age or spendthrift tendencies.
Testamentary Trusts provide complete flexibility both as to the nature and investments of the trust and as to the distribution of income and assets. For example, if you wish to restrict the control your spouse or child has over trust assets you could:
Appoint a third party as a Trustee and use a Discretionary Testamentary Trust;
Appoint a third party as a joint Trustee and use a Discretionary Testamentary Trust; or
Restrict access to the capital in the Trust by only allowing access to income and/or small percentage of the capital as determined by you using a Protective Testamentary Trust.
Duration of the Trust
A Testamentary Trust can remain in force for up to 80 years and therefore protection of trust assets can be for a substantial amount of time.
Other Consideration Before Incorporating a Testamentary Trust Under Your Will
Administrative Costs in Maintaining a Testamentary Trust
It is important to note that there will be ongoing administrative costs in maintaining and implementing the terms of the Testamentary Trust such as accountancy fees for Trust Tax Returns and Financial Reports.
Sufficiency of Trust Assets
As a matter of prudence, we would suggest engaging an Accountant or Financial Advisor to ascertain any risk management factors and to determine whether the anticipated income generated by your estate would be sufficient to warrant the establishment of a Testamentary Trust and meet the administrative costs which will be incurred in the future.
It is also necessary to confirm whether any of your assets are in fact owned jointly with another person or are subject to a family trust. This is important because any assets already subject to a current family trust may not form part of your estate unless you wind down the trust and transfer the assets into the sole name of the beneficiary.
If you are uncertain as to these details, a Testamentary Trust can be included as an option in you Will with the Trustee to make the ultimate decision whether to implement the Trust or not after your death.
Lisa Ruggero-Salerno is a partner of Vizzone Ruggero & Associates with a successful estate planning practice as well as family law. Please contact 02 9667 1271 or email firstname.lastname@example.org to discuss any part of this article or how Lisa can help you with your estate planning.