A testamentary trust offers a number of benefits including protecting assets from creditors, protecting vulnerable beneficiaries and potential income tax savings.
A testamentary trust is like a family trust but is created by the deceased’s will rather than a trust deed. The deceased leaves part (or all) of their estate to a trustee who holds the assets on trust for the benefit of a list of beneficiaries. The identity of the trustee, and the person who therefore controls the trust will depend on the purpose of the trust. We will look at each of these in turn now.
Testamentary Trust for Vulnerable beneficiaries
A beneficiary may be vulnerable because they have a disability that would prevent them looking after their inheritance or they may be likely to waste their inheritance due to addiction or some other affliction.
Whatever the case, by holding their inheritance in a testamentary trust, a trusted and reliable person can act as trustee and make distributions to the beneficiary only when needed and for legitimate purposes. This protects the inheritance while ensuring that the beneficiary is looked after,
In a discretionary trust, no particular beneficiary has any ownership interest in the trust assets, only a right to be considered by the trustee to receive a distribution. As a result, assets in a discretionary trust structure have traditionally been out of reach of creditors.
Courts are however, especially in relation to property disputes in family breakdowns, becoming increasingly willing to look behind the trust structure and find that the controller of the trust has an ownership interest in the trust assets. For this reason it is important to consider who will have ultimate control of the trust and whether an independent trustee should be appointed.
Nonetheless, the discretionary trust structure continues to provide asset protection in a variety of circumstances.
Income Tax Savings
A testamentary trust allows income to be streamed to beneficiaries with the most favourable tax circumstances. Unlike a family trust established by deed where children pay tax on distributions at penalty rates, minor beneficiaries of a testamentary trust pay tax on distributions at adult rates.
Consider the following scenario:
Jane is married with three children. Jane’s husband has no income and looks after the children full time. Likewise, Jane’s children have no income of their own. Jane’s father passed away recently leaving an estate of $1 million to Jane. The estate earns income of $60,000 per annum. Jane is employed full time on a salary of $180,000. Jane will therefore pay tax at her marginal rate of 45% on the income from the estate. This amounts to $27,000.
If, instead, Jane’s father had left his estate to Jane as trustee of a testamentary Trust. Jane, as trustee of the trust, could distribute the income of $60,000 in a way which was more tax effective. The trust could distribute $15,000 to each of her husband and her three children. As this amount is below the personal tax free threshold of each beneficiary no tax would be paid.
In this situation, a testamentary trust would have saved Jane’s family $27,000 per year!
If you are considering updating your will or want to find out if a testamentary trust might benefit your family, get in touch for an obligation free chat.
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