legal Tip 23: Why Set up a testamentary trust

Why use a testamentary trust


Here is a quick run down. A testamentary trust (TT) is any trust set up in a will. When you have some assets it is worth considering helping up your heirs by setting up a discretionary testamentary trust (DTT) in your will.


Some of the advantages of doing this are:

1. Asset protection on the bankruptcy of an heir
   

It you die and leave your spouse money and that spouse were to later become bankrupt the money would be susceptible to attack by creditors. A well drafted trust would provide extremely good protection against this.


2. Asset protection on divorce/separation of children etc

Imagine leaving all your assets to your child who gets divorced or goes through a defacto separation. Those assets will form part of the assets of the marriage and be at risk of falling into the hands of that evil spouse.

Using a DTT will segregate those assets inherited from the assets of the marriage. The DTT assets will not be assets of the marriage, they were not build up by the parties to the marriage and will therefore will be less likely to be attacked by the courts. There are different ways to structure the DTT to make this even stronger. However this is not foolproof.


3. Asset protection on spouse remarrying/Spouse’s death

Imagine you die and everything goes to the spouse. He/she meets someone at your funeral and they start a defacto relationship - same as above with divorce etc, but what if your ex-spouse died? The new spouse would then be entitled to the estate, whether there is a will or not (may have to share it with your children). To prevent or reduce this risk you could make it so that no future spouse of your spouse can ever become a beneficiary of your DTT and cannot act as trustee, appointor or be an office holder in any trustee company appointed.


This will assist in passing all of your assets to your children.


4. Asset Protection on death of beneficiaries.

Some people want to control things from the grave more than other people. Imagine you left $1mil to an adult child who died just 1 year after you did. Your $1mil can then pass on to whoever the child willed it to. Using a DTT means you can control the funds in case this happens.


5. Control release of capital

You could specify who can get access to the capital and when. You might want the children to have access to the income (rents, interest and dividends etc) of the trust, but to not be able to withdraw the capital (houses, shares, cash etc) until they all reach the age of 25 or 35, or until your youngest grandchild reaches the age of 25.

This will stop or limit spenders.


6. General Tax Advantages

If the trust is discretionary the trustee will be able to divert the income each year in a tax effective manner to the beneficiaries with the lowest taxable income. This can save a lot of tax.


7. Extra Tax Advantages for Children’s Income

Minor children can generally only year $416 per year before they are taxed at 66%. But because of s102AG ITAA36 children are able to receive income from a will or a trust under a will and be taxed as if they were adults. This means each child could earn approx $20,500 per year and not pay tax.


Imagine you die and leave $1mil in insurance proceeds. If this was left to your spouse she/he would invest it and if the earnings was $50,000 (5%) this would go on her other income and she would be taxed at say 37%. If it was left to the estate and via your will to a DTT the income could be distributed to the 2 children at $25,000 each. They would pay tax of a $1257 each compared to the wife’s tax of about $18,500.



8. Superannuation can be segregated

Superannuation proceeds are taxed depending on who receives the funds and the component of super. Where the superannuation death benefits are paid to the estate the general wording of the will may mean the beneficiaries of the super could be a non dependant. This will cause the super to be taxed. However where the DDT is set up to include a sub-trust for superannuation proceeds (a super proceeds trust) the beneficiaries of this sub trust can be restricted so as to be limited to dependants. Your super can therefore be controlled via the DTT and all the usual benefits of the DDT obtained.


9. Long term strategies

The DTT can invest and continue on for up to 80 years with all the tax advantages and asset protection advantages continuing. Your children can use it for other strategies too such as

1. the trust could lend $1mil to the daughter to buy a main residence in her personal name. The trust would have a written loan agreement with her, could lend at 0% pa, and could take a 1st registered mortgage over the property. If she later went bankrupt the $1mil would be protected by the mortgage. She would get good asset protection, save interest, and have the flexibility to cause for the loan to be called in and reissued later if she wanted to move house. And she gets the land tax exemption and the CGT exemption because the house is owned in her own name.
   
   
2. The son decides to become a developer. He can set up a separate trust, trust B, so the DTT, trust A can lend trust B some money for the development yet not be exposed (other than the money lent) if things go wrong.
   
   
3. The daughter might decide to start buying rental properties. the 20% deposits can be borrowed from the DTT with interest payable to divert income into the DTT and then out to children tax effectively.
   
   
4. The DTT itself could be used to invest directly in investment property, taking 80% loans. income would be more tax effective but there is a risk
   
   
5. DTT deed could be drafted for multiple trusts, so DTT A could be used to conduct the risky property investments with DTT B being the safe holder of assets. If a tenant were to sue they would sue the trustee of DTT A and B’s assets would be safe.
   
   
6. The DTT could run and operate a business
   

There are probably more advantages which I will add later as I think of them.

 

the trust could lend $1mil to the daughter to buy a main residence in her personal name. The trust would have a written loan agreement with her, could lend at 0% pa.

wouldn't the loan have to be commercial? etc i rent my ip to my daughter at 50% market rent. the ato would not agree with this when i went to claim neg gearing.

wouldn't this be the same as the creditors could easily argue that it was not set up as a commercial deal and in fact only used for asset protection?

 

A person can lend on any terms they choose. A trustee can only lend on the terms they are authorised to - under the deed and/or the Trustee Act.

ATO only gets involved where there are tax issues. Where a trustee is lending to a beneficiary at 0% there are no tax issues. The beneficiary is not increasing their deductions - they are not claiming any, and there are no income issues from the loan as there is no income.

A creditor would have no basis to argue that. The money is not the daughter's so there are no claw back issues. If the trust is discretionary open class with power to accumulate income etc then no beneficiary will have any interest in the trust other than its proper administration. So a creditor would have little hope to go on.

 

.....Or the Trust could provide the proceeds for Ms X and a Deed of Apparent Purchaser identify the trustee as the potential legal owner. Ms X would just be an apparent purchaser. While Ms X would be on legal title at any time the trustee could transfer the asset back (no duty) and her boyfriend would have no asset to attack......

 

Not sure of the reasoning behind this. It would be a bare trust arrangement so should be no CGT main residence exemption and no land tax advantages.

 

and the family courts could not over turn this? (if there was no children) it sounds to easy..

 

Family courts can attack testamentary trusts.

but they provide improved protection as the assets of the trust will not be 'assets of the marriage', If assets are inherited they become part of the estate of the marriage.

Trusts can also be attacked as a financial resource of a party to the marriage - depending on how it is structured.

 

I've just read Trust magic (updated 2015) and have a few questions about a dt with corporate trustee structure. my questions are related to using a dt for property purchases / holdings

1. how is income considered from a trust? does it go towards your serviceability? or no because it's not guaranteed income as the trustee can give to which ever beneficiary?

2. i'm under the understanding that i can give 30k to my sister etc and it'll be taxed at a lower rate and then she can gift it back to me? and it's possible to do this every year legally?

3. dt what type of private expenses can i pay for with "before tax dollars" it mentions in the book you can pay travel allowance. but i would think this is only if you're travelling to a ip etc? could use travel expenses for your own job which isn't related to the properties? i would have thought no?

4. one pro i found is that if you use rp data or buy investment books you can claim this as research? i believe this is correct?

5. can the dt claim depreciation on a property? how does this work?

 

1. Yes income from a trust can count towards serviceability. But with a discretionary trust there is no guarantee any beneficiary will get any benefit the lenders will want to see 2 years financials of both yourself and the trust.
If trust income is your only income then it will pose problems.

2. Yes - but what are the legal consequences

3. none. Entity does not change deductibility.

4. No. Research like that is not claimable. It doesn't relate to current income.

5. yes

Be careful relying on a book. It is just a basic outline - a little knowledge can be dangerous.

 

quick reply! 2. what do you mean by legal consequences?

4. what if you were wrapping and this was a business. so research obviously is part of the business? this point made sense to me as i thought it reasonable for it to be claimable. if it was buy and hold i could understand it not being claimable unless it was like a full time business with heaps of properties bought yearly.

 

Once you give something away it no longer belongs to you.

If you are running a business then it is different. Expenses before purchase such as rp data, inspection trips etc may be deductible. But the question is 'is it really a business'?

 

oh so you mean as in the consequences is that beneficiary could run off with your money? i thought the same. but if you trusted that person i feel like it could work well. also a bonus for them is that it'd increase there borrowing capacity. and with that. does that mean for serviceability that beneficiary would have to show 2 years financials before it would increase there serviceability i'm guessing yes?

 

You gifting to someone else won't count towards serviceability as a gift is not income.
A trust distribution is different. The trustee distributes income to the beneficiaries and this can count towards servicing.

If you gift to a person the may intend to give it back, but what if they die before doing so? What if they later die? What if they get divorced.

 

Hi @Terry_w
My mother is currently getting her will set up.
She intends to leave me her PPOR and to my sibling her other assets (mainly shares)
The shares are to be held in a TT and my sibling paid income from dividends
I've been asked if I'd prefer the house to be held in a separate TT or not.
My intention would be to sell the house and purchase shares for dividends, (and potentially retire)
I would have scope to income split with spouse and/or kids which I understand would be an advantage of TT from your comments above.
I'm wondering if there'd be any reason not to use the TT option?

 

Do testamentary trusts still have a vesting date?

 

You and your mum should seek legal advice. The testamentary trust could be optional - but be careful who decides this at the time.

 

Yes as per normal.

 

Thanks Terry.
Do participants to income splitting from a TT need to be nominated beneficiaries of the TT?

 

Only a beneficiary can benefit from income of a trust.

 

Hi Terry, saw this post and was looking for information on if a testamentary trust would also assist in the case for non-residents who have been left an inheritance? For example, they are now a permanent resident in the UK.

I imagine that country would have it's own tax law on how it treats inheritance?