Estate planning relates to advising the family group prior to the death of a member of the family. The purpose of an estate plan is to move the assets from one generation to the next so as to provide some measure of asset protection and seeking to reduce the prospect of adverse tax consequences and stamp duty exposure. The movement of assets from one generation to the next is obviously a time when substantial restructuring in the family asset holding occurs.
Potentially, a lack of planning to effect such a restructure could give rise (either at the time of the restructure or at some later time) to the risk that the assets of the estate are available to satisfy the claims of creditors or unfavourable tax outcomes.
The client should also be concerned with the potential transfer of assets/wealth from other persons to the client. Will a parent leave assets to you through your parent’s will? If so, you should consider the parent’s estate planning so that such assets are not bequeathed directly to you but rather to appropriate entities under your control. This can potentially achieve major taxation advantages as are discussed below.
Problems with traditional wills
Traditionally, a will has been drafted on the basis of leaving ones assets directly to the surviving spouse or children of the marriage. This traditional type of will:
- puts at risk your inheritance being lost to:
- creditors of your beneficiaries where your beneficiaries become bankrupt or become subject to legal claims. This is particularly relevant where the beneficiaries run their own business or give guarantees or are directors of companies or potentially liable to professional negligence claims; and
- the spouse or partner of your beneficiary where a family law dispute arises. The inheritance can become an asset of the relationship which in practical effect can be claimed by the spouse of your beneficiaries on the breakdown of that relationship;
- does not allow you to protect young children or children with problems such as a mental disability, gambling problems or drug or alcohol abuse;
- does not provide the ability to ‘split’ the income generated from the investment of the inheritance and thereby potentially reduce the amount of tax paid by the beneficiaries.
Testamentary Trusts
Modern wills use testamentary trusts as a way of seeking to gain protection against creditors of beneficiaries and taxation benefits that are otherwise unavailable to some beneficiaries of estates.
A testamentary trust is simply an express trust created by the transfer of property by will with the intention that the property be held in trust for others under the terms of the will.
A trust is not a separate legal entity in the same way as an individual or a company. Rather, a trust is a relationship which exists whereby a person (trustee) is compelled to hold property for the benefit of others (beneficiaries).
In the case of a testamentary trust, the testator (person who makes a will) provides in their will for their property to be held by another person (trustee) for the benefit of their nominated family members (beneficiaries) rather than those family members owning the testator’s property directly.
Three Main Benefits of Using a Testamentary Trust will
1. Protecting your inheritance from creditors of your beneficiaries
A properly drafted testamentary trust may reduce the ability of creditors of the beneficiaries from getting access to an inheritance to satisfy any claims. The beneficiaries can still use the assets and benefit from the inheritance but because they do not own the assets the rights of creditors may be reduced.
Further, a properly drafted testamentary trust with more than one beneficiary in control of the trust (say the children of the testator) may reduce the rights of a spouse of one of those beneficiaries from claiming the inheritance or part of the inheritance on the breakdown of the relationship with the beneficiary. In a properly drafted testamentary trust the inheritance in the testamentary trust may reduce the inheritance becoming an ‘asset of the marriage’ of any beneficiary which the Family Court may order be given to an ex-spouse of your beneficiary.
2. Protecting your beneficiaries from themselves
A properly drafted testamentary trust allows you to set rules about how and when your beneficiaries are to enjoy the inheritance. Many people today do not consider that an 18 year old has the knowledge and experience to properly handle a valuable inheritance and are at risk of wasting that inheritance.
A testamentary trust can be drafted to allow your younger beneficiaries to benefit from the income of the estate (so as to provide them with funds to assist with living expenses) but prevent those children from accessing the capital value of the estate to a later age say 30 or 35. In this way the young children are still provided for but do not have a large inheritance fall into their lap until a time when they are more mature and have more experience. Hopefully they may have also learned to work hard and provide for themselves without relying solely on your inheritance.
More sophisticated testamentary trusts can be used to protect beneficiaries from themselves, say when they have a mental disability, gambling problems or abuse drugs or alcohol.
3. Taxation Benefits
A properly drafted testamentary trust may provide significant taxation advantages that are not available in traditional wills.
Firstly, the testamentary trust can in practical effect allow your beneficiary to control the assets and who is entitled to the income generated from those assets without necessarily being required to return all of that income as their own. The income can be ‘split’ among different family members or entities as determined by the beneficiary or beneficiaries in control. This can allow an effective ‘splitting’ of the income so that tax is not paid by the one beneficiary at a potentially high marginal rate of up to 46.5% but can be ‘split’ against many beneficiaries with a potentially lower overall tax cost.
Secondly, income derived from a testamentary trust is usually treated as “excepted trust income” for tax purposes so that minor children are taxed as adults. Generally, minors can only receive nominal amounts of income (less than $1,000) before they are taxed at a penal rate of 46.5%. This penal rate of tax does not apply to income from a testamentary trust and minor children are taxed the same as adults in reference to the income to a minor from a testamentary trust. This is a great benefit to assist in the costs of raising children.
As such, we strongly recommend to most clients that they draft a will incorporating a flexible testamentary trust.
Property that can be given away in a will
It is fundamental in an estate plan which relies on the testator’s will to know precisely what assets will form part of the estate and what assets will not (and therefore need to be dealt with separately).
A clear statement of the assets and liabilities is an essential first step. The ownership of the assets is more important and should be confirmed by formal searches. There are many times that people say they “own” assets when the asset is not legally owned by them but by some other entity such as a family company or trust.
Copies of trust deeds, if any, together with financial accounts of all associated entities should be provided. One aspect that should especially be reviewed are the balances of loan accounts owed to or owing by the client.
Only assets that you own by yourself or your share of an asset that you own as a ‘tenant in common’ with somebody else will generally form part of your estate and as such are dealt with as part of your will.
Assets that are not necessarily governed by the will may include:
(i) some jointly-owned assets;
(ii) Superannuation entitlements;
(iii) Life insurance – depending on the terms of the Policy;
(iv) Assets owned by a Trust (e.g. a Family Trust);
(v) Assets owned by a company
A brief general summary of the assets that do not pass pursuant to a person’s will are set out below:
Decisions must be made as to whether each of these assets should form part of the estate and be dealt with as part of the will or be dealt with exclusively by other means and documents.