When engaging in estate planning, choosing the right type of Will is crucial to:
- ensure your assets are managed and distributed according to your wishes; and
- affording asset protection and tax effectiveness for your beneficiaries.
Individuals are often faced with a choice between a simple Will and what is called a Testamentary Trust Will. Understanding the benefits of each can help you make an informed decision that best suits your circumstances and the needs of your beneficiaries.
What is a simple Will?
A simple Will is a common type of Will prepared by solicitors and is what many clients think is sufficient to meet their estate planning needs.
A simple Will does the following:
- Appoints an executor to manage your estate and distribute assets directly to the named beneficiaries; and
- Outlines how your assets should be distributed upon your death, often making ‘simple gifts’ of your estate assets to your beneficiaries, which they take in their personal names.
Whilst these types of Wills are easy to implement and may be suitable for non-complex estate planning circumstances, they offer minimal to no tax effectiveness or asset protection for your beneficiaries, and they don’t necessarily account for beneficiaries:
- who practice in professions where they are likely to be sued (e.g. financial advisors, lawyers, doctors);
- who are vulnerable; or
- who have trouble managing their finances or have substance abuse issues.
Under a simple Will, your beneficiaries would simply have to take their inheritance in their personal names, and any income generated as a result of that inheritance (e.g. rental returns on property, interest on invested bank account funds or dividends) would require the beneficiaries to pay the marginal rate of tax. Depending upon the size of your estate, this could result in your beneficiaries going from a low tax rate threshold to a higher tax rate threshold.
In addition, if your beneficiaries were to marry and subsequently get divorced, then under a simple Will structure, their inheritance would be vulnerable and open to dissipation in the subsequent family law property settlement.
However, simple Wills (where appropriate) can be beneficial in the following ways:
- They are typically more cost-effective;
- They make for a timely administration of an estate; and
- May be sufficient in the case of smaller estates, where there are no concerns about asset protection or tax planning and the beneficiaries are financially responsible.
What is a Testamentary Trust Will?
A Will including Testamentary Trusts can help to address the issues highlighted above by giving your beneficiaries both tax effectiveness and asset protection over their inheritance.
A Testamentary Trust Will operates by creating one or more trusts that come into effect upon your death. These trusts are managed by the Trustees appointed under your Will. It is the role of the Trustee(s) to manage or control not only the Trust but also the distribution of assets or Trust income to the beneficiaries according to the terms specified in the Will and the Testamentary Trust Deed.
Common structure of Testamentary Trusts
- Where a beneficiary has reached the ‘preservation age’ (this is the age at which you consider your beneficiary capable of responsibly managing their inheritance), they have the option of taking their inheritance in their personal names as a simple gift (similar to what would occur if you had a simple Will) or taking their inheritance (or part thereof) under a discretionary testamentary trust structure (a ‘discretionary trust’); and
- Where a beneficiary is under the preservation age (i.e. a minor or simply under the age which you have set as the ‘preservation age’), their share of your estate is automatically held under a Testamentary Trust with the appointed Trustee(s) managing the trust until the beneficiary reaches the preservation age.
Once the beneficiary reaches the preservation age, they then have the option to take control of their Trust (if applicable), opt out of the Trust or continue with the Testamentary Trust structure.
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Advantages of a Testamentary Trust Will
- Beneficiaries who have reached the preservation age have the option of taking their inheritance inside a trust structure or taking their inheritance in their personal names (opt out of the Testamentary Trust). This provides flexibility, allowing your beneficiaries to make a choice that is most suitable to their personal and financial circumstances.
- Beneficiaries, together with the appointed Trustees managing the trust, have the option to split and stream income and capital generated from the Trust to other beneficiaries who form part of the class of ‘potential/secondary beneficiaries’, such as children or partners. This can potentially allow for more tax-effective distributions of Trust income and capital among beneficiaries.
- Testamentary Trusts also offer significant tax benefits. Income distributed to minor beneficiaries (under 18 years of age) from a Testamentary Trust may be taxed at adult rates rather than at the higher penalty rates typically applied to minors. This can result in substantial tax savings.
- A Testamentary Trust can protect assets from potential threats such as creditors, legal claims and family law disputes, given that the inheritance is not owned by the beneficiaries in their own name but by the Trust.
This is particularly beneficial, where there are concerns about separation or divorce or where a beneficiary is likely to be sued.
In such circumstances, the assets under the inheritance may not be available as part of the asset pool in family law property settlement proceedings and may not be available to creditors or third parties. However, it should be noted that to afford such protection, the Trust will need to be managed by the beneficiary (as Trustee for their own trust) together with another appointed Trustee.
- Where the beneficiary is under the preservation age, the inherited assets are protected and applied productively towards the beneficiary’s maintenance, advancement and support until they reach the preservation age.
- Testamentary Trusts can also provide for and afford greater protection for vulnerable beneficiaries, including beneficiaries with special needs, without affecting their eligibility for government benefits (e.g. NDIS). By carefully structuring the trust, you can ensure that these beneficiaries are still able to receive the benefit of their inheritance under your estate while preserving their entitlements to public assistance.
- The primary beneficiary (via the Trustee) can have the Trust wound up at any time.
- Testamentary Trusts can also offer greater flexibility in managing and distributing assets. Trustees have the discretion to manage the trust’s assets in the best interests of the beneficiaries, adapting to changing circumstances and needs over time. This flexibility can be crucial in managing complex family dynamics or unexpected financial challenges.
Disadvantages of a Testamentary Trust Will
- Cost: These types of Wills can be more costly to prepare, and cost is often dependent on the level of complexity.
- Administration of an estate where the Will is a Testamentary Trust Will is also a more complex process.
Choosing the right type of Will for your estate planning needs
Deciding between a Testamentary Trust Will and a simple Will depends on various factors, including the size and complexity of your estate, the needs and circumstances of your beneficiaries, and your goals for asset protection and tax planning.
Here are some considerations to help guide your decision:
- Complex family situations: If you have a blended family, minor children, or beneficiaries with special needs, a Testamentary Trust Will can provide the structure and protection needed.
- Significant assets: For larger estates, the tax advantages and asset protection offered by Testamentary Trusts can be highly beneficial.
- Financially inexperienced beneficiaries: If your beneficiaries are young or not financially savvy, a Testamentary Trust can help ensure that their inheritance is managed responsibly.
- Cost and simplicity: If your estate is small and your wishes are straightforward, a simple Will might be the most cost-effective and efficient option.
Get help from an estate planning lawyer
Both simple Wills and Testamentary Trust Wills serve important roles in estate planning, but they cater to different needs and circumstances. Understanding the benefits of each type of Will can help you make an informed decision that aligns with your estate planning goals.
Consulting with an experienced estate planning lawyer can provide further guidance about what type of Will would be best suited to your circumstances and estate planning needs. Get in touch with one of our lawyers to find out more.
Contact David Davis Lawyers
Phone: 03 9014 1299
Email: admin@ddavis.com.au