How a Testamentary Discretionary Trust can help protect your assets

When considering the inheritance you leave to your loved ones, the question of how your assets will pass to your beneficiaries is just as important as what you leave them.

A Testamentary Discretionary Trust (TDT) can re-assure you that your hard-earned assets won’t be wasted or attacked by creditors or ex-spouses. Using a TDT to pass on your assets can often result in better outcomes than an outright gift.

A TDT can be an advantageous for your beneficiaries by:

  • Providing significant flexibility
  • Minimising tax
  • Protecting assets

TDTs can have some downsides, and can involve administrative costs.

Before deciding to establish a TDT it’s important to receive advice from an experienced source, such as the team at Partners Legal.

A TDT is a special type of trust that is created as part of your will

Trusts have been around for centuries and have well-established rules designed to protect both the trustees and the beneficiaries. A trust is an ownership structure where the assets are owned by one person or organisation known as the trustee. However, those assets are held on trust for the benefit of other individuals known as the beneficiaries.

The TDT is not set-up until you pass away. Then, instead of your assets passing directly to your beneficiaries, they pass to the trustee of your TDT. Your assets are then held in the TDT on behalf of your beneficiaries according to the rules set out in your will. Your will becomes the TDT ‘deed’, which governs how the TDT is to be managed.

When creating a TDT under your will, you choose which assets will be in your TDT. For example, you can choose certain assets, a specific portion of your estate, or the whole of your estate. Not only can you choose which assets are in your TDT, you can also create multiple TDTs under one will which each hold different assets. You can establish the rules of each TDT separately, so these rules will reflect your intentions and fit the circumstances of each beneficiary.

One of the key features of a TDT is that it is discretionary. Therefore, the trustee can be given as much or little discretion as you wish to choose how to distribute the capital and income to your chosen beneficiaries. 

Who are the key people involved in a TDT?
The Trustee

The trustee is the legal owner of the property, and has control over the assets of the TDT. The trustee is appointed by you under your will, and it is often the executor of your will.

The trustee can be one or more individuals, or a company. If the trustee is a company, it is the directors of the company who will have day-to-day control of the assets and operate the TDT.

The trustee is able to make distributions to your beneficiaries from the TDT, and they have the discretion to determine how much each beneficiary receives. Therefore, it’s important that the trustee you appoint has the skills necessary to manage your assets in the TDT, as well as the appropriate personality to manage the beneficiaries’ expectations.

Appointor

Although the trustee is responsible for the day-to-day running of the TDT, many trusts also have an appointor (also commonly known as a principal, guardian or nominator).

The appointor can appoint and/or remove a trustee at any time, and their consent may be required to make any changes to the rules of the TDT.

Because of this, the appointor has the ultimate control of a TDT. You can nominate who the appointor of the TDT is in your will.

Beneficiaries

The TDT structure enables the capital, as well as income that is earned by that capital, to be distributed to (or withheld from) the beneficiaries of the trust in such proportions as the trustee decides.

Primary Beneficiaries: Typically, you will nominate a small number of people in your will who can expect to receive distributions from the TDT. These people are commonly referred to as the primary beneficiaries, and are the people you wish to benefit from your estate.

Discretionary Beneficiaries: You might also specify a larger number of beneficiaries who are eligible to receive income from the TDT. They may be spouses, siblings or relatives of the primary beneficiaries, charities, or other trust or corporate entities in which a beneficiary holds an interest. These people and entities are often referred to as discretionary beneficiaries. 

The main reason for including many discretionary beneficiaries is to allow the trustee maximum flexibility when distributing income in the most commercially beneficial and tax-efficient way. Having a wide number of beneficiaries also provides protection by making it more difficult for a creditor to definitively state that any one beneficiary stands to receive the assets.

What are the advantages of a testamentary discretionary trust?
It’s all up to you

It’s important to understand that some of the advantages of a TDT come with corresponding disadvantages. The more discretion you build in, the greater the chances that the decisions made by the trustee might differ from your decisions had you not passed away. Conversely, the more you limit the discretion of the trustee, you run a risk of limiting the best financial outcomes that could be achieved.

It’s a balancing act, and Partners Legal can help you work through the pros and cons to draft your will in a way that best suits your intentions.

Flexibility for your beneficiaries

A TDT can give the beneficiaries flexibility and control over when and how they receive their inheritance. The trustee can decide the appropriate amounts to distribute from the TDT to any of the beneficiaries, having regard to the needs of each beneficiary and what is most tax-effective in any given year.

Your will can also allow the TDT to be wound up at a certain point (up to a maximum of 80 years).

Protection of assets

The TDT structure legally separates the inherited assets from the beneficiaries’ own personal assets.

The assets in a TDT are not legally owned by the beneficiaries, and they do not have a fixed and certain right to any of assets in the TDT until the trustee decides to distribute.

This means a TDT will provide the inheritance with a far greater level of protection from situations where those assets could be taken by third parties, such as legal proceedings arising from a broken marriage, relationship breakdown, or bankruptcy.

You can also use a TDT to protect your assets if you’re concerned that your assets might otherwise be squandered by a beneficiary.

There are many ways to structure your TDT and Partners Legal will be there to guide your thinking and choices.

Taxation advantages

Taxation laws are continually changing, and it’s likely that the tax laws that exist at the time you draw up your will almost certainly be different at the time of your death.

A significant advantage of The TDT is that it provides for flexible tax outcomes due to the discretionary powers given to the trustee under the will. This allows the taxable income or capital gains generated by the assets of the TDT to be allocated to the beneficiaries in the most tax-effective manner.

Another important advantage of a TDT relates to beneficiaries under 18 years of age. The potential for tax savings when trust income is allocated to children may be substantial. This is because rather than being taxed at the higher penalty tax rates which normally apply on ‘unearned income’ of minors, they will be taxed at normal adult rates.

Effectively, this allows every beneficiary under 18 to receive up to $18,200 tax-free from a TDT each year. As a result, the potential for tax savings when trust income is allocated to children may be substantial.

Example[1]

Here is an example that shows the power of a TDT. Let’s suppose that you have an adult beneficiary with a spouse whose incomes are taxed at the top marginal rate of 45%. They have two children under the age of 18 who have no income.

The inheritance you leave the beneficiary consists of assets worth about $500,000, comprising a mix of property, shares and securities, the anticipated annual income from this inheritance is:

Property Income (net)

$12,500

Interest

$1,000

Dividends

$10,000

Imputation credits

$4,200

Total taxable income

$27,700

 
Option 1: Your beneficiary receives and holds inheritance directly

Tax payable:

Tax on $27,700 @ 45%

$12,465

Less imputation credits

$4,200

Tax payable

$8,265

Net cash received ($23,500 - $8,265)

$15,235

 
Option 2: Your beneficiary receives inheritance as trustee of a TDT

Your beneficiary can choose to distribute the TDT’s income to their children (both of whom would also be general beneficiaries of the TDT) in equal shares.

Taxable income

Distribution per child

$11,750

Imputation credits

$4,200

 

Tax payable

Tax on $11,750 (x2) @ 0%

Nil

Less imputation credits

$4,200

Tax refund

$4,200

Net cash received

27,700

 

If your beneficiary received the inheritance directly, the income they would receive from the inheritance is $15,235 per year.

If they receive the inheritance through a TDT, allowing income to be streamed to their minor children, the income from the inheritance is $27,700 per year.

This represents an after-tax cash saving of $12,465 each year (over $1,000 per month!) for your loved ones.

Partners Legal can help

As part of Partners Wealth Group, Partners Legal is uniquely placed to assist you with your estate planning needs. Our team is experienced in the planning, structuring and establishment of testamentary discretionary trusts and can help bring you the peace of mind that comes from knowing that your assets will be safe and your intentions for your loved ones fulfilled.

If any of this resonates with you, or you would like to explore your options, please contact:

Patrick Robertson
Partners Legal
Level 13, 636 St Kilda Road
Melbourne VIC 3004

T 0437 544 052
E probertson@pwg.com.au

[1] This example is general. It may not apply in all cases and individually-tailored financial and taxation advice should be sought before relying on this.

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