This article was written by Joanne Carusi, Special Counsel and Emma Blay, Solicitor from Barry.Nilsson. Lawyers. They are not the opinion of FIIG nor are they FIIG employees or associates.
In recent years the need for effective structuring of personal and business assets has been brought to the forefront of the minds of business owners and high net worth individuals.
Key changes to the taxation regime, the increasing amount of wealth being accumulated in superannuation funds and the growing propensity for both personal and business relationships to be rather short term (as opposed to life long) have meant that “traditional estate planning” has been revolutionised.
Consequently, more sophisticated estate planning strategies have been developed in order to minimise the possibility of wealth being attacked by former spouses, creditors, business associates and (sometimes), disgruntled beneficiaries.
There are many factors to consider when completing your estate plan, particularly if asset protection and tax minimisation are high priorities.
Choosing a Solicitor who specialises in Wills and Estates is crucial to review your family and financial situation and tailor an estate plan to suit your specific needs and objectives.
Often this estate plan will incorporate a “Will with Testamentary Trust” rather than a “Standard Will”.
A Standard Will, in its simplest form, is a testamentary document confirming a Willmaker’s choice of executors, beneficiaries and testamentary wishes regarding the distribution of their estate. It does not, however, offer any asset protection or tax minimisation benefits.
A Testamentary Trust Will is a type of Will that establishes a Trust or Trusts upon the death of the Willmaker. This kind of Will is designed to protect the Willmaker's assets because they belong to the beneficiaries’ Trust rather than the individual. This allows flexibility for how capital and income generated by those assets is distributed. The Trust is not ‘activated’ until after the death of the Willmaker.
The Trustees who decide how the income is distributed can also be beneficiaries of the Trust. However, the Trustees must act in accordance with the provisions set out in the Will regarding how the Trust is to be managed.
There are two commonly utilised types of Testamentary Trusts:
- Discretionary Testamentary Trusts – where the Executor gives the beneficiary the option to take part or all of their inheritance via a Testamentary Trust. The primary beneficiary has the power to remove and appoint the trustee and they can appoint themselves to manage their inheritance inside the Trust.
- Protective Testamentary Trusts – where a Beneficiary must take their inheritance via the Trust and does not have the option to appoint or remove trustees. This is useful where the beneficiary is not in a position to responsibly manage their inheritance due to age, disability or spendthrift tendencies.
Subject to the drafting of the Will (and in contrast to a Standard Will), potential advantages of Testamentary Trusts include the following:-
- Asset Protection for the beneficiaries in the event of marriage or relationship breakdown (if the Trust is utilised effectively);
- Asset Protection for vulnerable beneficiaries including spendthrift beneficiaries, disabled beneficiaries or beneficiaries with a drug, alcohol or gambling problem;
- Asset Protection for “at risk” professionals or beneficiaries who may face claims from creditors or bankruptcy;
- Protection of pension entitlements;
- Income splitting advantages e.g. adult children, minors and/or other relatives on low incomes;
- Income tax advantages for children under 18 (who are taxed at adult rates instead of penalty rates outside the Testamentary Trusts environment); and
- Flexibility for the Trustee to exercise discretion about management and investment of capital and to take account of changing needs of beneficiaries.
If a beneficiary takes their inheritance in their personal name (via a Standard Will), they will pay tax on the income generated from their inheritance at their personal marginal tax rate.
There may be significant tax advantages in taking an inheritance through a tesTamentary Trust, particularly where the beneficiary has:
- a high personal marginal tax rate
- a partner on a lower income
- children and/or grandchildren who are minors or who have no, or a lower taxable income
- a tax free threshold of $18,200 (all Australian residents)
- a tax free threshold of $20,542 (Australian residents who qualify for low-income offsets).
The Trustee or Trustees can choose to distribute the income generated by the Trust in a way that minimises the tax burden of the beneficiaries. Depending upon the assets held in the Trust, a Testamentary Trust can potentially save tens or even hundreds of thousands of dollars over its lifetime.
Fred Smith dies having prepared a Standard Will prior to his passing.
Fred leaves an estate worth two million dollars. He is survived by his two adult children, Bam Bam and Pebbles.
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Fred leaves his whole estate to his children who already earn income which is taxed at the highest marginal tax rate (45% plus levies).
In the first year after Fred’s death, Bam Bam and Pebbles receive income of $40,000 each from the investments that they had inherited.
As they each already have an income being taxed at the highest marginal rate, they will both pay tax of around $19,600 on the $40,000 income (total tax paid $39,200).
If Fred had the provision in his Will for Testamentary Trusts to be established and if Bam Bam and Pebbles established the Trusts upon Fred’s death then Bam Bam and Pebbles could have distributed the $40,000 between their respective dependant’s (i.e. spouse and minor children) (e.g. for their medical needs, education and living expenses). Each dependant (spouse and children) did not earn an income (salary etc.) and therefore no tax would be payable despite each child being treated as an adult for tax purposes.
Therefore, in one year alone, the tax saving would have been $39,200.
When it comes to protecting wealth and making provision for loved ones, it is essential to get it right. This means seeking legal advice from a Solicitor specialising in Wills and Estates to ensure that your estate plan is tailored to the specific needs and objectives of yourself and your family.
FIIG strongly recommends that you seek independent accounting, financial, taxation, and legal advice, tailored to your specific objectives, financial situation or needs, prior to making any investment decision. FIIG does not provide tax advice and is not a registered tax agent or tax (financial) advisor, nor are any of FIIG’s staff or authorised representatives.
This article was written by Joanne Carusi, Special Counsel and Emma Blay, Solicitor from Barry.Nilsson. Lawyers.