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How does a trust protect inherited assets?
Modern Wills have two primary functions.
The first is to do everything possible to ensure that your nominated primary beneficiaries end up with your estate so that your wishes are met.
The second is to ensure that the inheritance they receive is protected long-term from third party threats and unnecessary taxes. These protections and tax advantages are achieved by allowing beneficiaries to receive their inheritance in a testamentary trust.
Only Wills that include the required legal provisions and trust terms can provide beneficiaries with testamentary trusts.
Bankruptcy & Other Financial Problems
Testamentary trusts provide protection to your beneficiaries from the repercussions of bankruptcy. For instance, following a business failure or other financial troubles whereby the beneficiary owes creditors.
Assets that pass to a testamentary trust from an estate are held for the benefit of the nominated primary beneficiary only until the trustee (who is usually also the primary beneficiary) elects to distribute such assets.
At law, the assets are not owned personally by the beneficiary and therefore do not form part of the beneficiary’s personal estate. A creditor or other person claiming against the beneficiary, therefore, cannot obtain the assets held in the trust.
Divorce & De Facto Break-up
Testamentary trusts also provide protection for a beneficiary who is experiencing family law difficulties following a divorce or de facto break-up.
With the inheritance held in a testamentary trust, the primary beneficiary can isolate inherited assets from personal assets. This substantially helps to protect their inheritance from family law property proceedings where the court views assets held in a testamentary trust separate from the pool of assets being contested during divorce or de facto break-up court proceedings.
Tax Advantages
Testamentary trusts give a beneficiary the option to reduce personal income tax by splitting income from the investment of the inheritance between a range of family members on low tax rates. The trustee of the testamentary trust (normally the primary beneficiary) has complete discretion to determine who receives the income of the trust. Tax is paid on the income of the trust at the marginal tax rate of the beneficiaries who receive it.
Therefore, by selecting beneficiaries on low marginal tax rates, the trustee can minimise the tax liability of the trust. The trustee can choose to distribute income to minor beneficiaries of the trust with each beneficiary being able to receive over $18,200 of income tax-free to pay for education and living expenses.
For a one million dollar estate that is invested for a modest 5% return, this equates to $50,000 income per year, which if distributed among children or low-income family members could equate over ten years to half a million dollars tax saved for the benefit of your family rather than the ATO.
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Testamentary trusts also provide the opportunity for beneficiaries to minimise Capital Gains Tax which arises from the sale of assets. Capital Gains Tax is not triggered when an asset belonging to you passes via your Will to your executor or the trustee of a testamentary trust. Also, there is no Capital Gains Tax when your assets are transferred from the trustee of a testamentary trust to a beneficiary. As with the income of the trust, the trustee can select which of the beneficiaries of the testamentary trust should take the capital gain.
By choosing to distribute the capital gain to a beneficiary on a low or nil income, the capital gains tax liability can be significantly reduced. Holding the assets of an estate within a trust offers the beneficiaries an opportunity to defer the need for the sale of assets (and therefore capital gains tax) until later when more numerous beneficiaries come into existence. Tax deferred is tax saved.
Normally penalty rates of tax apply to income derived from trusts which is paid to children under age 18.​ The Tax Act allows children under age 18 who receive income from a testamentary trust to be treated as adults for tax purposes. This could mean significant tax savings for beneficiaries who can “split income” with their minor children. Over 10 years this could be mean hundreds of thousands of dollars for your family rather than the ATO.
Divorce & testamentary trusts?
Many questions about testamentary trusts centre around divorce and de facto break-ups.
There is great interest in keeping family wealth in the family, and out of the hands of an ex-spouse or former de facto partner.
One of the key reasons for beneficiaries (i.e. you, your spouse or partner & your children) to inherit via a testamentary trust is that that inherited wealth does not fall into the hands of someone outside the family, but instead can be passed down to the next bloodline member of your family (i.e. a beneficiary’s children or grand-children etc).
Testamentary trusts achieve this providing protection for a beneficiary who is experiencing family law difficulties following a divorce or de facto break-up.
With the inheritance held in a testamentary trust, a primary beneficiary can isolate inherited assets from personal assets. This substantially helps to protect their inheritance from family law property proceedings where the court views assets held in a testamentary trust separate from the pool of assets being contested during divorce or de facto break-up court proceedings.
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These valuable protections can be passed down to the next generation, as testamentary trusts can last for 80 years.
What if my spouse or partner remarry?
The most common way of a couple owning their home is as ‘joint tenants’ which means that on the death of the first co-owner, the survivor becomes the sole owner as a jointly held asset goes directly to the survivor, bypassing the Will completely.
This gives rise to the risk of losing part of, or the whole home, if the survivor, or their estate, is sued by a future spouse or domestic partner or a creditor following a relationship breakdown or money troubles.
An alternative approach is to change the title to ‘tenants in common in equal shares’, a tax-free low-cost procedure, which means on the death of a spouse, the survivor can hold the deceased partner’s share of the home under a right of occupation as provided by all Wills from Will Wizard which protects at least that part of the home from such third party claims.
Bankruptcy & testamentary trusts
Testamentary trusts provide protection to your beneficiaries from the repercussions of bankruptcy. For instance, following a business failure or other financial troubles whereby the beneficiary owes creditors.
Assets that pass to a testamentary trust from an estate are held for the benefit of the nominated primary beneficiary only until the trustee (who is usually also the primary beneficiary) elects to distribute such assets.
At law the assets are not owned personally by the beneficiary and therefore do not form part of the beneficiary’s personal estate. A creditor or other person claiming against the beneficiary, therefore, cannot obtain the assets held in the trust.
Addiction, mental health & testamentary trusts?
Our focus at Will Wizard® is to provide Wills that aim to help protect family members and their inherited assets long term.
One of the ways we do this is to include special crisis provisions.
These special provisions come into effect when a beneficiary experiences some kind of personal or financial crisis such as a relationship or marriage ending, a mental breakdown, a drug addiction, being sued or having a business fail.
The executor is able to temporarily remove the beneficiary as trustee (the controller) of their testamentary trust, distancing them from their inherited assets when it could be under heightened risk from third party claims or poor decision making.
Beneficiaries going through a crisis will still have access to funds for living, health, education and welfare expenses until the crisis has passed.
Once the crisis has passed, the beneficiary can resume full control over their inheritance.
Given the many issues, these crisis provisions help protect against, the statistical probability that you, your spouse or partner, or one of your children or grandchildren will need these provisions to protect their inherited assets at some point during their life is incredibly high.
Case Studies
This short series looks at the different personal and financial consequences of one family when the parents rely on a basic Will verses when they rely on a comprehensive Will that provides testamentary trusts and other modern risk preventative measures.
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