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A common question that we often get asked by our clients is “How can I protect assets left to my children from in-laws if their marriage breaks down?”

The best way to achieve greater control over the distribution of the assets in your will is to establish a testamentary trust.

A testamentary trust is also highly beneficial when splitting income with young children or where asset protection strategies are required (for instance if a beneficiary is in a high risk occupation).

What is a testamentary trust?

A testamentary trust is a trust established in a will that comes into effect upon the death of the person making the will. The assets are held in the trust with income or assets distributed to the individual later. The trust can be fixed or as flexible as you like with discretion given to the nominated trustee over what and when is distributed.

Protect inheritances from in-laws

A lineal descendant trust is designed to keep your inheritance for your lineal descendants and out of the reach of the Family Court.

How this works

Person A dies and leaves their child $700,000 in inheritance.

No trust

• The $700,000 is passed on immediately to the child and is likely invested in their mortgage and other assets

• A few years later child and partner separate

• The Family Court takes into consideration all matrimonial assets which total to $1M after the deduction of mortgages and distribute $500,000 to partner and $500,000 to child.

Lineal descendant trust

• The $700,000 is distributed to the LDT

• A few years later child and partner separate

• Child and partner’s assets amount to $400,000 after deduction of mortgages

• The court takes into account child’s inheritance however because of the terms of the LDT these funds were not available for distribution to partner.

• Partner is distributed $200,000  and child is left with $700,000 in LDT and $200,000 from matrimonial assets.

It is important that the LDT has been properly drafted otherwise the Family Court may find that its assets are available for distribution.

Inheritance to young children

In the case of families with young children a testamentary trust can help generate extra income to support the surviving family and minimise tax.

This can also provide additional protection if the surviving partner remarries and that marriage subsequently breaks down.

How this works

Person A dies and leaves their partner and children $700,000 and 25% share in the family business.

No trust

• The $700,000 is passed on immediately to the partner

• Business generates $100,000 income a year for the partner which is taxed at their personal tax rate

• Partner remarries and subsequently gets divorced

• Original inheritance is then split between partner and new husband with the Family Court deciding how to divide the assets

Testamentary trust

Person A dies and their wealth is distributed to the testamentary discretionary trust according to the will

• Partner is made trustee

• Partner uses the trust to distribute income to themselves and their three children

• Partner is able to receive $82,168 tax free each year for themselves and their children

• Partner remarries and subsequently gets divorced. The inheritance is not divided between the new husband and partner.

Asset protection strategy

If your children are in high risk professions and have put in place asset protection strategies receiving a direct inheritance can present unanticipated problems.

How this works

Person A dies and leaves child $700,000 property

No trust

• $700,000 property is distributed to child

• Child operates her own business

• Child can continue to keep the property in her own name and have the property at risk of creditors if anything goes wrong in her business

• Child can decide to protect the property by transferring it into a trust but has to pay $23,000 in stamp duty

Testamentary Trust

• $700,000 property is distributed to trust

• No additional effort is required by child to protect the property from the risks of her business

Disadvantages of testamentary trusts

There are additional costs associated with establishing a testamentary trust and management of the trust upon the death of the testator. These are minimal however in comparison to the benefits the trust provides, particularly in the case where there is significant wealth involved.

What a trust doesn’t protect against

Family members can still contest your will so if the distribution of assets amongst the family is not considered ‘fair’ it can still be altered.

Am I better off with a testamentary trust?

Every circumstance is different and there is no one-size fits all solution to estate planning. It is important that you discuss estate planning with your accountant and lawyer to come up with the best option for your family. If you haven’t reviewed your estate planning recently, or if you are interested in knowing more about testamentary trusts, please speak to your MGI advisor.

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About the author

Cameron Barber

Director, Taxation Consulting & Business Services

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