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Testamentary Trust Wills - what are they and why are they better than a standard will?

David Patkin, Principal of our Estate Planning team, explores the versatile applicability in asset protection and tax efficiency, of this essential estate planning tool.

Testamentary trusts are an effective estate planning tool to help ensure your estate is distributed in accordance with your wishes and that your assets remain in the control of your beneficiaries or trustees as intended.

A testamentary trust is simply a trust that is established by the terms of your Will. Therefore in making your Will, you have an opportunity to incorporate terms that establish trusts specifically designed to achieve the distribution that you require.

Naturally each Will maker has their own wishes and reasons for the way in which their estate is to be distributed. There are, however, common uses of testamentary trusts that fall into the areas of tax effectiveness and asset protection.

Tax effectiveness

Income generated by an inherited asset in the hands of a beneficiary will add to that beneficiary’s personal income tax. However, if that inherited asset is held in a testamentary trust controlled by the beneficiary then the beneficiary has a variety of options in dealing with the income from year to year. The testamentary trust also provides flexibility allowing the beneficiary to vary their options as tax laws and the beneficiary’s own personal circumstances change over time.

For example, if the beneficiary has minor children and/or a spouse on a low marginal tax rate, then the current tax laws allow the beneficiary to split and distribute income to their spouse and children in a more tax effective manner based on their individual tax profiles.

A testamentary trust can also be used to distribute different types of income to different beneficiaries of the trust. For example, the trustee may distribute capital gains to a beneficiary who has significant capital losses against which these gains can be offset.

Asset protection

Testamentary trusts can be used to provide a number of options for your beneficiaries to protect their inheritance from external threats such as an estranged spouse or a failed business.

For beneficiaries who are spendthrifts, have substance abuse problems or are intellectually or financially vulnerable you may impose more restrictive testamentary trusts to protect their inheritance from themselves.

Relationship breakdown

For a beneficiary who is involved in a relationship breakdown, a testamentary trust can be used to avoid the inherited assets mixing with those assets acquired during their marriage. While there is no certainty in family law disputes and depending on the circumstances of the dissolution, a testamentary trust may assist in preserving the inherited assets or enhancing settlement negotiations.

Financial or legal problems

For a beneficiary who is having financial or legal problems, a testamentary trust can be used to avoid the inherited assets mixing with the beneficiary’s personal assets and so benefit from a higher level of protection.

Gambling or substance abuse

For a beneficiary with gambling or substance abuse issues, a more restrictive testamentary trust can be used to provide an income for the beneficiary but restrict access to the capital that produces the income.

Second marriages

If, following a divorce, there is a desire to provide an income and place to live for a subsequent spouse but ensure that the assets ultimately pass to the children of the first marriage then this can be achieved via a more restrictive testamentary trust.

Staggered distribution

Rather than a beneficiary receiving 100% of their inheritance at a certain age, a testamentary trust can be used to distribute the inheritance in smaller portions over time. This not only allows the beneficiary to deal with their inheritance gradually as they mature but also offers them a second or third chance if they make poor financial decisions.

Education Fund

An education fund is a testamentary trust established in a Will to provide for the education expenses of certain beneficiaries. If you are currently providing such financial assistance for education, this can be continued in you Will.

This is by no means an exhaustive list of the uses for testamentary trusts. At R.B. Flinders we welcome the opportunity to discuss the use of testamentary trusts as a part of your estate planning.

Contact David for a confidential chat about your estate might benefit from a testamentary trust will.

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