If we’ve ever caught up for a coffee or if you’ve heard me speak at a seminar, you will know that Testamentary Trusts are my FAVOURITE estate planning tool. I get asked all the time about testamentary trusts: are they worth the money or just over complicating things? Short answer? I believe that a testamentary trust can be a game changer in estate planning for about 80% of the clients I meet.

Check out my video which explains what testamentary trusts are, why they are so powerful and when you should consider using them.

If you want to dive further into the world of testamentary trusts check out my other blog posts:

If you would really like to sharpen your knowledge about testamentary trusts, my Testamentary Trust Starter Pack is the perfect place to start.  You can find out more at https://www.taralucke.com.au/free-conversation-templates/

Transcript

Hi, it’s Tara Lucke here. In this video, I am going to talk you through why testamentary trusts are one of my favourite estate planning tools. So, I passionately believe that most people will receive enormous value from including a testamentary trust in their will. So, what I want to do today is basically get you comfortable with what a testamentary trust actually is, how they work, when to use them, whether you should be using one and also basically get you comfortable with the awesome asset protection and tax planning advantages that the testamentary trust can offer to your loved ones. So, let’s get stuck into it.

Okay. So testamentary trusts. Now I just want to get one thing straight. You’ve probably heard the phrase testamentary trust, testamentary discretionary trust, TT, TDT, and I want to let you know that they all mean the same thing. It is just lawyer speak for a trust which is set up in the will which starts on death. Okay. There’s lots of different phrases that people use but basically, a testamentary trust is a trust that you put into your will, it doesn’t start until somebody passes away. Now if you’ve heard of a family trust or if you’ve got one, then you’re already ahead of the game because a testamentary trust is very similar to a family trust. They operate in almost an identical way. It’s just that the testamentary trust goes into the will. It’s basically dormant or it doesn’t start until you pass away.

Now, why do I love testamentary trusts? Why do I think they’re so powerful? Because they protect inheritances from bankruptcy, from divorces and relationship breakdowns. They help protect immature beneficiaries or beneficiaries who cannot look after their money, so whether that’s because they’re just too young at the moment or there is substance abuse issues, disability issues, for whatever reason. They’re great for protecting beneficiaries from themselves, they’re an awesome tax environment. The government basically gives everybody a tax break who uses a testamentary trust because they recognise that to have the trust come into existence, somebody had to die.

So, let’s start with a crash course on trusts. This applies to most trusts, so family trusts and testamentary trusts. The key feature of a trust is that we are separating control from the right to benefit. So, above my very wobbly line is where the control sits and the benefit sits below that line with the beneficiaries. So, you need to know about the trustee. The trustee has control of the asset in the trust, so in this case, the inherited asset. They have the legal control, they have the day-to-day management and they are in charge of trusts. The trustee runs the trust for a range of people who are called the beneficiaries. Now, people who are beneficiaries can get a benefit from the trust. So, typically the trust will list out a whole heap of people. So for instance, it will usually be the surviving spouse, the children, grandchildren, great-grandchildren, sibling, nieces, nephews, aunts, uncles, cousins, grandparents, parents on both sides of the family and any trusts or companies that they’re involved in. So, there’ll be a huge range of beneficiaries. But no one beneficiary has any right to receive anything in this type of discretionary trust whether it’s family or testamentary trust.

So, the right of the beneficiaries is just to be considered by the trustee, so, the trustee basically chooses which of the beneficiaries should receive a benefit, how much and when. So, the role of trustee is really important. Now of course if you’re a trustee and a beneficiary, then it’s probably going to look and feel like your money. You won’t even notice the separation. But if you’re not a trustee, you’re just a beneficiary, then you may receive something from the trust, you may not. It will be up to the trustee.

Now, there is this other role called the appointor. It’s actually optional, you do not have to include one. Sometimes, that’s called the principal or the guardian. They are the ultimate controller, almost like the God of the trust because they can come in and sack the trustee at any time. So, the trustee does all the hard work. They do all the day-to-day management. The appointor doesn’t do much. It just sits there sort of dormant and then if it wants to take action, it can come in, sack the trustee and put whoever they want in there. So, this is trusts in a nutshell.

The reason I’m labouring the separation between the control that sits with the trustee and the benefit is because you’ll see this in some of the demonstrations I use. And also, the fact that the entitlements of the beneficiaries are not certain or fixed, that they are up to the trustee is really important. It’s that discretion with the trustee, which is key to these trusts offering the awesome tax and asset protection. So, that’s enough about trusts. Let’s get into some practical examples. Why would you use a testamentary trust? I want to start with looking at what happens when we don’t use a testamentary trust. So sometimes we call this the I Love you, may be better described as the I hate you offering. But let’s start here because you probably heard about this type of estate planning strategy, most people are familiar with that.

Let’s take our scenario. We’ve got a young couple, mum and dad in their 40s and then they’ve got let’s say, two young children, put another child in here. Under this option, if our mother passes away, wife passes, she leaves everything to the husband 100%. Looks and feels as his assets, he owns them. If he passes away as well, then our two kids share everything until they’re about 21. So, we’ll have guardians in place, financial controllers who manage the children’s inheritance until they turned 21, and then when they turn 21, they get their money and they run. So they get the share of the inheritance. Does that sound familiar what you think of when you’re making a will?

And that this option, it does not offer any asset protection, whether that’s from divorce or bankruptcy. So, if our husband has survived, but our wife has passed away and he repartners, new spouse here, and they go through a bust-up, the inheritance that she left him for him and their kids together is up for grabs with that new spouse. Same if he gets in trouble with business or any occupation. If they’ve both passed away and we’ve got our two young kids if they turned 21 and they get their inheritance and they’re not ready, too bad. There’s nothing that close family members and friends who are keeping an eye and supporting those kids can do about it to protect them from themselves.So, if they’ve gone off the rails, and look, I think we’ve all, you know, seen and heard of examples where this has happened. To be honest, if you’re under 21 and you’ve lost both parents, who can blame you for taking a little bit of time to find your feet? But they’re not ready to manage the inheritance when they turn 21. Too bad. It doesn’t matter what the family around them says, those kids have control of their money.

So, the other option is using a testamentary trust. So this is our testamentary trust example and I want to use it to demonstrate how it works for asset protection and tax. So in this situation, we’ve got our same couple, but our wife has died, she leaves the home to the surviving husband, keep it simple. He just has the home in his name but everything else goes into the testamentary trust, this is the triangle. Now, we make our husband the trustee so he’s in charge, remember the trustee has control. The people that can benefit will be predominantly our surviving husband and their kids, then all of the extended family. But because our husband is in control, it is going to look and feel like his money because he can choose whether he gives the benefits to himself and his kids, just to his kids, just to himself, whoever he wants. He is in charge, he will have the trust. But he may not even notice the trust there other than it offering awesome asset protection and tax.

So, if we’ve got our husband and he repartners with a new spouse and they go through a bust-up, there is a great big separation, almost like a firewall between the assets that were inherited in that trust and his assets that are available in divorce proceedings to his second ex-spouse. That is so much harder for that ex-spouse to attack the assets in that trust. They’re basically not available. Now, it’s never bulletproof with family law. But he has, you know, a 100-meter head start if he did have a testamentary trust. If we are talking bankruptcy, they’re just not available, full stop. So you cannot get this kind of protection without a testamentary trust. With the no testamentary trust option, if he repartners and they go through a divorce, the inheritance is all up for grabs.

The other thing that I love is the income tax. So I don’t want to bore you with tax, we don’t, you know. This isn’t about a tax lecture. But the one thing you need to know is that minors can get about 22,000 tax-free income from the inheritance which generates income every year every minor. Every minor per annum. So, what does that actually mean in practical terms? If we have, say, I don’t know, 50,000 of income that the inheritance earns, say there was like $1 million in life insurance and super that went in here, that earns a 5% return at 50,000 and he’s got, two kids. The first $44,000 of that income is tax-free and then we’ve got a bit of tax on the $6000 left, which is just at the children’s marginals rates, so pretty low rates. So he can basically have no tax paid on the income from investing the inheritance and he can use that money to pay for the living expenses and their education.

Now the kids don’t get $22,000 in their bank account every year, It’s paid on their behalf towards expenses that the family would have incurred anyway. This is huge. The government only lets you have this treatment in a testamentary trust because someone has died, in this case, the mum. The tax savings don’t start until somebody dies. You can’t just make a will and start getting access to it. But if somebody dies, you then get into this tax treatment. This is massive for families. This is a difference sometimes between public school and private school and being able to afford it because you’re paying so much tax less than everyone else. And it’s generation on generation. So, when our children here grow up and have children of their own, they can then do the same with their kids. So that’s massive.

The other thing that I love about testamentary trusts is that they protect the minor or immature beneficiaries. So if mum and dad have both died, the kids don’t get their inheritance when they turn 21. They can get it when they’re 30 or 25. And we basically put in charge loved friends, families, trusted people to manage the money for the children and choose when is an appropriate time for the kids to get control. The kids will benefit the whole way through, but they don’t get to make financial decisions about the inheritance until they’re ready, until trusted people choose that they are ready. So, that can be huge in preserving the inheritance for the children rather than it being blown when they turn 21.

And if you’ve got beneficiaries who might never be ready because they’ve got a disability or substance abuse problem or gambling or something, then we know you’ve got peace of mind that they are provided for as needed, but the basic capital of the inheritance is protected and not exposed to those risks. Now, there is also awesome opportunities for tax planning with overseas beneficiaries and also ruling from the grave and we can get really creative with some of these control structures and manipulating the benefit and control dynamic. So this is why I love testamentary trusts so much, they have awesome asset protection and tax. You cannot get this outcome anywhere else.

So I want to just reiterate it is essential that we use discretionary testamentary trust to get the asset protection, but the discretionary element will not really matter if we put the trustee and the beneficiary the same. So in this case, our surviving spouse was the trustee and the beneficiary. So from his perspective, it looked and felt like it’s his money. And he can do things like shut down the trust, change up the investments, pull out lump sums and take everyone to Disneyland, buy new assets, pull out money and pay off a mortgage or use the money in the trust to refinance. It will look and feel like your money if you’re a trustee and a beneficiary so we’re not handcuffing people to a restrictive structure. The same if you’ve got adult children and you want to make sure that the money that you leave them is protected from any divorce risks that they have. If you put them in charge as the trustee and the beneficiary, it will still look and feel like their money, but they’ll have a head start on asset protection.

So I want to be clear. You might have heard this. Testamentary trusts, they are not just for rich people. Okay? They are for everyday families who have money, where they want effective tax and awesome asset protection. And they are not just for complex situations. In fact, all of my friends who get married or have kids, I give them testamentary trust wills. Now I am not the most popular person at the baby shower. I will admit that. But it’s so important that everybody who needs one has a testamentary trust. So here’s my framework on when a testamentary trust could be useful and I have to note I cannot give you specific legal advice through a video. Of course. You should be getting specific tailored legal advice for your circumstances about whether a testamentary trust will be useful. But this is my guidelines or parameters about when you should start thinking about utilising a testamentary trust and get more advice.

So the first one is if you are going to leave a beneficiary at least $500,000, and that might be a group of beneficiaries, so, if the trust is going to receive at least 500,000 which include super and life insurance, then you should think about using one. And a lot of people go I don’t have that much money. But if you add up your super and life insurance, you might. Secondly, if you have got minors, kids under 18 who can get that tax-free income, you should be thinking about using a trust. This is a massive head start for families, especially when they have lost one or both of the parents. If you want to make sure that the inheritance that you are leaving to someone is protected from their divorce risks or bankruptcy, think about a trust.

Where you have beneficiaries who cannot manage their inheritance properly, a trust is really powerful. So when I’m saying they can’t manage their inheritance properly, it could be because we’ve got a substance or gambling problem, a disability, but it might just be because they are too young at the moment and they will be able to manage it properly in the future, but we don’t want them to get this money when they’re 21 and too immature. And lastly, if you’ve got a beneficiary living overseas temporarily who is not a tax resident, but might come back, there can be planning opportunities with the trust as well. And this is when you definitely need to get specific advice on, so I won’t delve into that here. But if you’ve got an adult child who is overseas for a few years and not an Australian tax resident anymore and Australian assets, think about that.

So my take-out message is when in doubt, use a testamentary trust. If you’re on the fence, put one in your will because you only get one shot. You cannot reverse engineer these advantages if you do not die with a testamentary trust in your will. It has to be set up before you die. So I always err on the side of caution. They can always shut down the trust if it’s not needed but if you die without one and they needed it, you cannot get the same outcome. So if you’re on the fence, use the testamentary trust.

The other thing, the trust only starts when you die. So a lot of people say what are the ongoing costs. There are no ongoing costs if you’re still alive with a testamentary trust. If you’ve died and the testamentary trust is in existence, you need a bank account and a tax file number and an extra tax return. If you’re carrying a business and stuff, there’s extra things but if it’s just for investments, an extra tax return, extra bank account. And if you’re getting those tax-free savings and asset protection advantages, then provided you’ve got, you know, a bit more than 500,000 or so in there, you’re going to see advantages that far outweigh the extra compliance costs.

Really just to sort of say if you’re going to leave someone a couple of hundred thousand and they’re just going to pay off their mortgage, you probably won’t need to leave them with the trust. Because if they just pay off the mortgage, the money goes there into the bank, they’ve got their home debt free and there’s nothing really to sit in the trust. So they’ll be paying a tax return, but not getting any tax savings or asset protection. So the 500,000 is certainly, there is no magic number to that. It’s really just a guide. But if you have investments where you’re earning an income in the trust that you want asset protection and the 22,000 tax-free for minors every year, this ongoing cost, you know, they’ll be marginal. The advantages will far outweigh them.

So, I think I’ve reiterated the advantages of testamentary trusts. Bankruptcy protection, relationship divorce protection, protecting beneficiaries from themselves, income tax savings. You can’t get those savings anywhere else. They allow you to be creative with strategies about controlling from the grave. But on the other hand, you can also set it up so that you’re not controlling from the grave and the recipients have their inheritance that looks and feels like their money in the trust and it can also help with overseas strategies.

So just to reiterate, did you hear me say that they are amazing for divorce protection? How about tax-free income? Like where else can you get that? These are the reasons why testamentary trusts are my favourite tool and why I think they’re so powerful for estate planning. Now I love talking testamentary trusts. So if you do have any questions, feel free to get in touch. Thanks for watching.

Start having estate planning conversations that work with my tried and tested conversation template!

Top 10 Mistakes When Nominating Financial Controllers

Top 20 Estate Planning Mistakes

Testamentary Trust Decision Making Cheat Sheet

10 Reasons Your Client Needs A New Estate Plan