This article was published in the WFO Magazine
Death is both extraordinary and ordinary; it happens every day, to every person, but each family experiences death and grief in different and unique ways.
In my inheritance law practice, I help many, many families. Because I help people with estate planning and have an extensive estate administration and estate litigation practice, I am keenly aware of the different impact that good, and bad, estate planning can have on families. In that it can exacerbate, or ameliorate, the experience that families have.
The way an inheritance is dealt with after death always leaves a lasting imprint – especially if it contributes to further family disharmony or brings long-supressed intra-family grievances to the surface (“She was always Mum’s favourite child!”).
This is why there is no “one-size-fits-all” solution to estate planning. This is why those “Do-It-Yourself” Will Kits, or online wills where there is no interaction with, or advice received from, a lawyer are just not good enough for your family.
The true value in seeing a lawyer for your estate planning is not just the legal advice you receive, rather, it is the unique practical advice, formed by years of experience, that you receive when crafting your estate plan.
One of the best estate planning tools for families is a testamentary discretionary trust within a Will. However, this tool will not be effective unless accompanied by advice unique to your family’s situation.
The Basics
A Testamentary Discretionary Trust (TDT) is simply a discretionary trust created by a Will.
Sometimes TDTs are called “testamentary trusts”. However, a testamentary trust is any trust established under a Will which may be a fixed trust rather than a discretionary trust.
A standard Will made by a couple who have children would appoint the surviving spouse as executor and the whole of the testator’s estate would pass to the surviving spouse. The Will would provide further that, in the event the spouse does not survive, the whole of the estate would be divided equally between the surviving children. The children may or may not be executors in this case depending on their age and whether the testator believes the estate can be administered by the children without any arguments.
When property is left absolutely to a spouse or children, those assets will be transmitted into the beneficiary’s name or converted to cash which is distributed to the beneficiaries. These newly acquired assets, in the hands of the beneficiaries, are then exposed to possible creditors, the trustee in bankruptcy and claims by a future spouse of the surviving spouse or where children are beneficiaries, claims by the children’s spouses.
The newly acquired assets of the beneficiary may also generate income upon which the beneficiary will have to be pay tax. The beneficiary may already be earning significant income and, accordingly, any additional income earned from investment of the inheritance may be taxed at one of the higher marginal rates.
In the case where the testator has provided a TDT in their Will, their assets will still pass into their estate, but the balance of the estate (after payment of debts and testamentary expenses) or part of the estate or specific assets may pass to the TDT rather than the beneficiaries absolutely.
The testator would identify the beneficiary or beneficiaries for whom the TDT is being established. I refer to these beneficiaries as the primary beneficiaries. The trust terms will also provide who are discretionary beneficiaries. These may be named beneficiaries or classes of beneficiaries.
The terms of the trust would nominate a trustee. This may or may not be the executor and may also provide for an appointor who has the power to appoint and remove trustees of the trust similar to the power of appointment contained in family discretionary trusts (also known as family trusts).
Advantages of TDTs
The primary reason for setting up a TDT is asset protection. Where the TDT provides the trustee with a discretion in relation to both income and capital, none of the beneficiaries have a fixed entitlement. They merely have the right to be considered for a distribution. Accordingly, they have no vested interest until the trustee appropriates the income or capital. Obviously, if a particular beneficiary is in financial difficulty or bankrupt, the trustee would elect not to make distributions to this beneficiary. The trustee may, however, elect to make distributions to that beneficiary’s family if, indeed, they are also beneficiaries of the TDT.
The trustee in bankruptcy will not be able to attack the assets of the trust. The trustee would only have a right to claim on assets appointed by the trustee for the benefit of the bankrupt beneficiary, but not yet transferred to that beneficiary. Further, the trustee in bankruptcy would have no claim to income of the trust unless it was already appointed for the benefit of the bankrupt beneficiary, but not paid and only amounts of income over the threshold amount.
With the high number of relationships and marriages ending and the increase in wealth available to pass on to their children, many testators are looking for ways to ensure that the inheritance their children receive is in some way protected.
When a couple separates, the Courts consider the contributions of each party to the relationship and also, to a degree, the needs of the parties when ordering a division of property. The fact that a party to the relationship which has broken down has received an inheritance from their parent will obviously count as a contribution made on behalf of the child of the testator. However, it is generally accepted that the longer the period between when the contribution was made and the separation, the less significance is placed on the contribution to an extent where, if that period is more than 10 years, the contribution may have little significance at all.
If, however, the assets are held in a TDT with a party to the relationship being the primary beneficiary, there is generally a good argument that the assets of that trust should not form part of the matrimonial property. Before a Court would consider trust assets as matrimonial assets, the Court would need to be convinced that the trust was being operated by a party to the marriage in such a way that the party was treating the assets as their own.
It must be remembered, however, that even though the discretionary beneficiaries have no vested interest in the trust, they still have the right to be considered and, in fact, if the trust was being operated in a way so that distributions were being made not only to the party in question, but to others, it would seem hard to imagine that the Family Court would make orders forcing the party to make a distribution from the trust to the other party to the relationship.
It should, however, be remembered that although the Family Court may not make an order in relation to the assets held in the TDT, the Court can consider the “rights” which a discretionary beneficiary may have or the possible distributions the discretionary beneficiary may obtain as a financial resource and adjust property rights held by the parties in other matrimonial property accordingly.
The writer is not aware of any Family Court decisions where the Court has ordered a party to marriage to do all things necessary to cause property from a TDT to be distributed to the other party to the marriage.
Obviously, the selection of the trustee of the TDT and appointor may be of some relevance. If the party to the marriage is not only a discretionary beneficiary, but also the sole trustee and appointor of the trust, there would be a higher likelihood that the Court may find that the assets held in the TDT are really assets of the party to the marriage.
This is another area where the value of advice from an estate planning lawyer is realised: the advice about the control aspects of the TDT, considered and given considering the will-maker’s specific and particular estate planning goals and objectives.
Another advantage of a TDT is flexibility. The trust can continue for a period of up to 80 years. During this time, the trustee will at least yearly consider what distributions of income should be made to beneficiaries and, from time to time, what distributions of capital may be made. Obviously, the needs of different beneficiaries may vary significantly and, accordingly, distributions can be made to meet these needs. Having said that, if TDTs were desired and there are several adult beneficiaries, separate TDTs would generally be established for each of the adult beneficiaries primarily for the benefit of each of their immediate family.
The question of whether separate TDTs for each child, or a single TDT for all children, should be utilised is another area where your estate planning lawyer can provide value. I do not come across many adult children who want to be financially bound to their siblings for the rest of their lives. However, the pros and cons of a separate or a single TDT is another thing that your lawyer should discuss with you as part of the estate planning process.
The other major advantage with TDTs is the tax savings that can be made. In particular, the fact that beneficiaries who are under the age of 18 get the benefit of the tax-free threshold and marginal tax rates. This can go a long way to free up cash flow in a household. Would you like your children to be able to pay your grandchild’s private school fees from “tax-free” money?
A TDT differs from a family discretionary trust in that distributions to beneficiaries under the age of 18 under a family discretionary trust are tax free only on the first $400.00 (approximately). Distributions over that are taxed at the highest adult marginal rates.
Myths About TDTs – What They Cannot Do
It is a MYTH that TDTs prevent the Will from being “contested”.
Depending on who controls the TDT, a beneficiary may not have certainty as to what they will receive from the estate. This could give rise to a consideration by the beneficiary to making a Family Provision Application and it must be remembered that the testator’s assets pass into the estate and do not pass to the TDT until the administration of the estate is complete.
This is another reason why proper legal advice is required: notwithstanding the benefits mentioned above, a TDT simply might not be suitable for your family’s situation.
Your Homework
Sorry, everyone hates homework! Maybe this should have been headed “checklist” instead?
The timing of death is uncertain. Think carefully. If you were to die tomorrow, are your affairs in order? What legacy are you leaving behind for your family?
The TDT is an estate planning tool that can be crafted to satisfy and meet many estate planning goals of a family, but they need to be drafted appropriately. Do you think it would help your family?
While I have you thinking, here are other important things to think about:
- How old are your children? If they are under the age of 18, who would care for them if you were to die?
- Are your children adults? What is the relationship between them like? Are they the best of friends? Do they share similar values? Or do they have little to do with one another other than scowling at each other across the dinner table? Is one of them better with paperwork than the other?
- Is your family blended? Have you ever had open and frank discussions about the needs and expectations of all family members are to be met in the event of your death? The ownership of the family home is often of great significance.
- If you are a business owner, what do you want to happen to that business when you die? Is a child taking it over? How would your other children feel about that (even if they have chosen not to participate in the business)?
The relationship between your children is often overlooked; an effective estate plan will take it into account.
Whatever your unique family situation, I hope that this article has provided you with some food for thought and has encouraged you to do the most important estate planning task: get started!
This article is intended for educational purposes only and is not to be relied upon as legal advice. If you have a legal problem or matter for which you require advice, please do not hesitate to contact the author.
The writer acknowledges the contribution of Michael Klatt, Partner at Mullins Lawyers, to this article.