Testamentary Trust

estate-plan
A Testamentary discretionary trust (TDT) is an important component of the modern estate plan and is mostly used to reduce tax and protect assets from the hands of unintended recipients. A TDT is, quite simply, a trust created by a person’s Will. Because a Will only operates on the death of the Will maker, a TDT only comes into operation after the Will maker’s death, when the executor transfers assets into the trust.

The key personnel of a TDT include:

  • The Trustee: is the person who controls the operation of the trust and is equipped with wide decision making powers, including powers to distribute income and capital among the beneficiaries, or to withhold distributions altogether.
  • The Beneficiaries: are persons entitled to receive distributions from the Trustee. The trust deed will typically distinguish between the “primary beneficiary”, being the person for whose benefit the trust was created and the “potential beneficiaries,” who are usually the primary beneficiary’s family members. If the primary beneficiary is an adult, is not disabled or is not otherwise a “spendthrift,” the Will would usually appoint the primary beneficiary to be the appointor and trustee of the TDT, and thus assume ultimate control over it.
  • The Appointor: is the person who holds the “keys to the trust” in that they have the power to “hire and fire” the trustee.

A TDT Will should be drafted to reflect the Will maker’s own unique circumstances and overall objectives. For example, the Will maker may decide to:

  • give their estate to their spouse absolutely in the first instance, with TDT’s only being created for their children if the spouse does not survive them;
  • Provide that certain beneficiaries receive their inheritance via a TDT while others receive it absolutely;
  • provide that the beneficiaries have the option either to receive all or part of their inheritance via a TDT or absolutely.
  • The above are only some of the many possible provisions that the Will could contain.

    Tax effectiveness

    The main tax advantage of a TDT arises because minor beneficiaries (for example, children and grandchildren under 18 years of age) are generally taxed at normal adult rates on distributions made to them. This means that minor beneficiaries are not generally taxed at penalty rates, and therefore have the benefit of the tax free threshold ($18,200 at the time of writing).

    The TDT should also allow for the trustee to stream any capital gains (i.e if a CGT asset held in the TDT is later sold) optimally among the beneficiaries.

    The potential for tax savings can be significant

    Let’s assume Janice dies at age 33 leaving an estate of $1,000,000, most of which comprises a life insurance payout. Janice leaves the whole of her estate (including the life insurance payout) to her husband Scott, now the sole parent of their 3 young children, Emma James and Mark. Scott invests his inheritance in an investment portfolio, which generates income of $54,000 in the first year. However, because Scott earned a salary of $120,000, the income from the investment portfolio attracted tax of $20,790 in the first year! Had Janice established a TDT, Scott could have distributed the trust income equally between the children (i.e $18,000 each to pay their school fees, dental bills etc), tax free (assuming the children did not earn any other income)!

    Asset protection

    Another reason TDT’s are attractive is because they offer some level of asset protection. A TDT does this by separating the underlying ownership of trust assets from the beneficiaries and giving it to the trustee.

    Asset protection could mean protecting an immature beneficiary from “themselves”, that is, to ensure that the beneficiary does not have control over their inheritance until they reach a certain age or, in the case of a beneficiary with a spendthrift tendency, to structure the trust in such a way that they never gain control over the capital, and are entitled to the income only.

    Another form of asset protection could be to protect the beneficiary from others, for example, claims on the inheritance from creditors or from an ex-spouse.

    Summary

    Because the cost of setting up (and operating) a TDT is more than the cost of a simple Will, a TDT may not be appropriate where the estate is relatively small. However, where the size of the estate makes tax and asset protection benefits important to the Will maker, a TDT can offer a superior solution.

    Forty Seven Legal offer a comprehensive Testamentary Trust solution. We take the time to understand your objectives and needs and formulate appropriate solutions.

    This information is general in nature only and does not constitute the giving of legal advice nor should it be relied upon as such. You should seek professional advice specific to your own circumstances.