Testamentary Discretionary Trusts – Essential Clauses

All families are different and all Wills are different to meet the needs of each unique group and asset structure.

Whether you are employed or own a business, if you are retired or accumulating money in your superannuation fund, are all questions that need to be addressed in the drafting of your tailored estate plan.

Asset protection

The asset protection of a testamentary trust is very important for at risk professionals that may be subject to claims for negligence or business creditors. If you have deliberately structured ownership of your main residence in the name of  a spouse then it is a problem if they die leaving it directly to you as sole beneficiary. It may be better for the family if the asset is held in a trust to protect it from those risks. Having the choice to receive a property in your name or held on trust is a key element to a well drafted Will. In the same way, shares and control of trusts that hold significant assets, must be considered carefully. If you have created “investment” trusts and “bucket companies” to hold assets away from your trading business entity, then you need to consider how those shares or the control of those trusts are owned. Perhaps the shares should be held “on trust” so that they are not exposed to these risks.

Choice to dispense with estate trust

It is a big question whether you leave the power to dispense with an estate trust in the hands of a beneficiary or knowing their circumstances you oblige them to create a trust that protects the capital and ensures an income stream for a longer term. Consider if they may need to access part of the capital for medical or other emergencies.

Future Control of estate trusts

It is crucial to look forward and think about what pressures will be faced by your beneficiaries to access the capital and if they are in any way vulnerable to external influences. They may have a history of financial risk, alcohol or drugs, gambling and just plain spendthrifts. It may be better to require a jointly controlled trust with a sibling or independent trustee, to ensure that they are not accessing the capital in a wasteful or speculative way. You might need to consider who can control the trusts if you want the capital to flow through to the next generation as part of your bloodline. Perhaps excluding spouses from controlling a trust, is a way to prevent loss of the trust capital and ensure the grandchildren get their share.

Powers of appointment

The key to protecting assets in an estate trust is by defining who is “eligible” to be a trustee and exercise power over the trust. If a person becomes insolvent, is subject to a matrimonial dispute or suffers a disability, then a default clause should deem them ineligible and the executors or a nominated person are then appointed. This removes the control of the capital away from the affected person and protects it for that person and the other beneficiaries. That control might be restricted to lineal family members and ultimate control might vest in the grandchildren.

Class of Beneficiaries

It is a crucial element of the estate trust to define the “class” or potential individuals that can receive distributions of capital or income from the trusts. The most common way is to include all descendants of a nominated test person usually the Will makers parents, as well as any companies or trusts in which any of those people have an interest. Consider if real property is involved whether foreign beneficiaries should be excluded if there are children who are non-resident taxpayers as a beneficiary and if a separate trust must be set up for them. This is because capital gains tax exemptions will not apply to non-residents and penalty rates of land tax may be incurred.

Assets to be held and ongoing management

It is very important to think about what type of assets are going to form part of the estate and how management of those assets will need to be addressed into the future. If it is a share in a trading company that owns a business perhaps a buy/sell agreement is required, so the cash is released from the asset and no further trading risk is incurred by your successor. This can be achieved by a special purpose life policy to ensure the proceeds are deemed to be the consideration for the share sale price. If it is a passive real estate investment then it may require a common trustee where there are several beneficiaries holding that property in their respective trust.

Administrative Requirements on establishing a trust

All estate trusts are created as at the moment of death and the assets are held by the executors until such time as the estate can be distributed. Probate or proving the Will by lodging an Application in the Supreme Court is usually required. This enables the assets to be sold, transferred or collected and all tax and expenses paid. Once a net amount is realised the executor can then transfer the share of the estate to the Primary Beneficiaries as trustee of their own trust. This is as simple as opening a bank account with a bank or finance institution in the name of the trustee for the trust as named in the Will.

It is crucial to remember that once money is taken out of a trust it cannot be put back in. For example if it is used to pay for part of the purchase price of a main residence, especially if held jointly with a souse. The capital is then out of the trust and at risk. It is better to “loan” the funds by a commercial loan document, so on sale of the property the money is returned to the estate trust.

You cannot add money or assets to an estate trust, otherwise it will lose its status as a trust that can distribute “excepted trust income”, to children under 18 years. The trust can sometimes “gear” its assets, or borrow to purchase an asset, subject to the restrictions set out in the Will.

The trustee can then apply for a tax file number and open an investment account just like any individual to purchase shares, managed funds or other assets. Real property is then transferred into the name of the trustee and they can start to receive the rent and will need to pay the outgoings such as rates and utilities for the property. Each year before 30 June the trustee must sign a resolution declaring how the income and capital gains are to be distributed to the “class” of beneficiaries. This enables the person to allocate income to children in the family under 18 years of age and they take it as “excepted trust income”, which is taxed at adult rates. This can minimise the tax burden on a family group over many years and will most likely pay for the costs of setting up the trust many times over.

Vesting the Trust

It is important to remember that the estate trust once established can run for up to 80 years from the date of death of the person from whose estate it is derived. This means that a family group over many generations can create a means of investing the capital and they can all share income from the trust each year. The capital can grow and be used at important stages of their lives such as deposits for homes, cars, study and overseas travel. If the capital is reduced and the tax advantages are limited, it may be within the discretion of the trustee to wind up the trust and distribute the balance of the cash. A Will maker can restrict the access to the capital until specific age requirements are met. For example access to capital might be limited to 25% at age 25 years, 25% at 30 years and the balance 50% at age 40 years, if it is a substantial amount. This staged control, can achieve the long term goals of the willmaker to ensure a secure income stream for the beneficiaries and capital protection for as long as possible. The appointment of joint trustees can assist in achieving these goals.

So you can see there are many aspects to estate trusts and thousands of ways to draft the Will to cover all family circumstances. We recommend a very detailed discussion with your financial planner and accountant to ensure the best possible outcomes and benefits for all family members. Ask us how. Go to our website www.perspectivelaw.com and click “Start My Estate Plan Now”.

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