A closer look at discretionary testamentary trusts
November 26, 2012
A testamentary trust is created by a will, and occasioned upon the death of the will maker. It can take the form of a discretionary or fixed trust.
A discretionary trust is one where the trustee has discretion as to which one (or more) of the named beneficiaries will share in the annual income of the trust – and in the capital of the trust fund. This also applies to classes of beneficiaries described in the trust.
A fixed trust is one where the property of the trust belongs beneficially to a nominated beneficiary. In some instances the ownership of the property is delayed for the term of the trust because, for example, the beneficiary is younger than 18.
The following circumstances represent typical situations whereby a discretionary testamentary trust may be suitable for a will maker.
An effective tax planning structure can be created within the framework of a testamentary discretionary trust so that income from the assets in the trust can be distributed in the discretion of the primary beneficiary to one or a number of beneficiaries (including minors) at their marginal tax rates.
To place some context around this, a more ‘typical’ will is not likely to provide these tax benefits. For example, in the circumstance of a typical family with parents and children, it is common for a husband to provide in his will that his estate be left to his wife, and for a wife to provide that her estate be left to her husband. It is also common to provide that if a spouse does not survive the other, the estate is to be divided equally amongst their children. This is usually subject to the children reaching a specified age, one at which the will maker considers the children will be capable of maturely managing the assets. While this approach provides simplicity and certainty, it offers no opportunity to minimize tax by distributing income amongst nominated beneficiaries, at the discretion of the principal beneficiary.
Income distributed to an infant beneficiary through a testamentary trust is taxed at normal rates. Thus, according to current tax rules, the first $6,000 of income given to a child through a testamentary trust is tax free to each child, and income in excess of this amount is taxed on the standard sliding scale. This applies to every year of income where a distribution of income to a child through a testamentary trust is made in this way. Within this framework, a trust created by a will can hold assets and distribute the income produced by those assets each year, tax effectively, to beneficiaries including the children or grandchildren of the will maker. The ability to distribute income to minors in this way is not available with trusts created other than by a will.
If the will maker has sufficient assets to warrant the inclusion of a discretionary testamentary trust in his or her will, then there are likely to be financial benefits for the surviving spouse and children.
Provision for a beneficiary with a disability
Parents of a child with a disability often wish to include a provision in their wills which addresses the future care of their child, whilst at the same time protecting assets for future beneficiaries. A trust for a disabled beneficiary can take different forms – one of which could be a discretionary testamentary trust. Within this context, a reliable trustee is permitted to exercise discretion with regard to the distribution of income and assets in the trust.
Protection of Assets
In some cases, a will maker may wish to provide for a beneficiary, but protect the assets allocated to that beneficiary. Circumstances where such a will may be required is where the beneficiary is a spendthrift, may have a difficult matrimonial situation, or may wish to keep assets away from creditors or potential creditors.
Discretionary trusts have long been used as a means to protect assets. There is clear authority that the interest of a discretionary beneficiary of a testamentary discretionary trust does not amount to a proprietary interest. For this reason, from the point of view of, for example, the Bankruptcy Act, a discretionary beneficiary does not own any of the property comprised in the trust. However it needs to be borne in mind that any claim against a beneficiary which seeks to access assets of the trust will be considered on the facts and factors such as who controls the trust will impact on whether the assets of the trust are available to creditors. Certainly, in matrimonial disputes the Family Court will go behind a trust to see who really owns the assets.
If you would like to discuss any aspects of a testamentary discretionary trust please contact Daniel Fleming at firstname.lastname@example.org.
This article is intended to provide general information in summary form on a legal topic, current at the time of publication. The contents do not constitute legal advice and should not be relied on as such. Formal legal advice should be sought in specific circumstances.