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Understanding estate planning and testamentary trusts

In the unfortunate yet inevitable circumstance of a person’s death, it is crucial for proper estate planning to be in place to help alleviate any further stress upon those left behind at such a difficult time.

The purpose of estate planning is to develop a strategy to manage a person’s assets after they pass away, with the appropriate legal structures and instruments, such as a will. One major consideration in regards to estate planning is tax, and competent guidance in the tax aspects of estate administration can prove vital in managing the risks. A deceased estate is fundamentally a trust, with the executor entitled as a trustee. However, the trust only exists as a legal entity until the estate is finalized, or “fully administered”.

Separate to the deceased estate

A testamentary trust is a trust which is established under a valid will, but is different from the trust of a deceased estate. A testamentary trust works similarly to a discretionary family trust, with specified provisions of the will functioning like a trust deed.

Like any trust, the trustee of a well-governed testamentary trust will:

  • Understand the tax profile of probable beneficiaries with specific regard to intended tax outcomes.
  • Lodge a tax return for the testamentary trust for every financial year that it is in existence
  • Maintain proper trust account records (such as trustee resolutions, detailed financial statements and reconciliations), especially where a trustee is streaming capital gains or franked dividends
  • Fully document capital gains tax events, cost bases, and rollovers and other concessions claimed.

Depending on who is appointed to the role of trustee, it may be required that family members have a high degree of co-operation in order to ensure that tax, financial and other information is shared in order to ensure the trust functions effectively.

The use of testamentary trusts.
When the deceased estate is fully administered, the executor becomes the trustee under the deceased’s will, and therefore holds the assets for which that position entitles.

Depending on the will of a deceased person, the terms of a testamentary trust may be different, however they generally function similarly to a discretionary trust. The trustee usually has discretion in regards to the distribution of capital and income, and the range of beneficiaries may be vast. This method offers a high level of flexibility, but a well-managed testamentary trust will ensure that the tax outcomes are realised and, crucially, legal disputes or family issues may be prevented.

The advantages of a testamentary trust can be as follows:

  • Asset protection – if the trust is a discretionary testamentary trust, no single beneficiary will have any claim on the assets of the testamentary trust. This will prevent the assets being exposed to a successful claim by a creditor of a beneficiary or being transferred as a consequence of family law proceedings relating to a beneficiary.
  • Distribution of income and capital – the trustee can generally distribute the income of the trust to any one or more of the general beneficiaries, allowing the trustee to distribute the income in the most tax effective manner. The trustee will have similar discretions in relation to the capital of the trust.
  • Income distributed to infant beneficiaries – the income generated by a testamentary trust can be distributed to infant beneficiaries and taxed in their hands at the normal adult marginal tax rates.
  • Providing for several generations – often, a deceased would want to be able to provide for their surviving spouse and their children thereafter. A typical will usually transfer all the asset to the surviving spouse; after which it would be necessary for the surviving spouse to write another will that passes down the assets to their children.

The establishment of a testamentary trust enables assets to be administered for the benefit of successive generations. The deceased can provide a direction that the testamentary trust be administered firstly for the benefit of the surviving spouse and thereafter for their children.

Furthermore, the surviving spouse can take control or be appointed as a trustee until death or incapacity. Subsequently, control over the trust can be given to the children. This facilitates successful and effective family succession planning.

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