Law Talks Episode: Why a Testamentary Discretionary Trust could be the best strategy for protecting family wealth

Robyn: Good morning and welcome to another edition of 4CRB’s law talks and today we have joining us from Attwood Marshall Lawyers, Wills and Estates Associate Natalie Comerford. Thanks for being here today, Natalie.

Natalie: Thanks for having me back, Robyn.

Robyn: Well, our topic is about planning for the next generation and keeping up with the Joneses. Now I had to laugh when I read this topic, keeping up with the Joneses. It is very interesting concept in the context of estate planning, so I’m eager to hear what you have to say about this one Natalie.

Natalie: Well, keeping up with the Joneses is an idiom that we’re all familiar with. And there’s absolutely no harm in keeping up with what everyone else is doing these days. So, it’s actually good to know what’s going on. And after all, word of mouth can be such a valuable learning tool to improve our lives.

So, these days in the field of estate planning, I can tell you we have so many Joneses families. With property prices soaring and the age of superannuation maturing, we need to ensure that the wealth is passed on efficiently and effectively to the next generation.

In Australia, the expected transfer of intergenerational wealth is set to reach unprecedented levels, with an estimated value of over $3 trillion dollars. Honestly, Robyn, this is a figure I cannot even comprehend. And this phenomenon has sparked interest in innovative estate planning strategies. Like the use of testamentary discretionary trusts as tools to pass that generational wealth.

Robyn: So, what exactly is a testamentary discretionary trust and how does it work?

Natalie: So, a testamentary discretionary trust is a trust created through a will, which comes into effect upon the death of the will maker. So it grants the trustee of the trust the discretionary powers to distribute income and capital to a range of beneficiaries who are defined within the will. So commonly included beneficiaries are the will maker’s spouse, children, grandchildren and other family members and even charitable organisations.

The Joneses are key are keen to protect the wealth that they’ve accumulated and through the use of a testamentary discretionary trust in their wills provides the perfect way to ensure that their hard earned assets are protected and distributed wisely and fairly.

And most importantly, end up with the intended beneficiaries.

So, the way this structure works is that the inheritance is passed into the trust instead of directly to the beneficiary. The inheritance housed within the structure is managed by the trustees of the trust. Now, these are people that are appointed within the will and they’re responsible for the ongoing management of the inheritance. The trustees make the day-to-day decisions about what’s going to happen to the money in the trust.

So, for example, they may invest the money to generate more income, and because it’s a discretionary trust they also get to decide who gets what from the income or even the capital.

Robyn: OK.

Natalie: Now the beneficiaries, on the other hand, are those that have the right to benefit from the inheritance and any income that’s also generated from that inheritance.

There are different levels of beneficiaries within a testamentary discretionary trust.

The trustees have the power to distribute to any of the beneficiaries, and often they can be strategic advantages to the distributions they make. For example, tax benefits to minor beneficiaries.

So, think of the trust like a money bank. The trustees are in charge of the money bank and it’s their job to divvy the contents out to a list of select people. There are rules that the money bank has, and the trustees must stick to these rules. So of course, if they divvy out all the money at one time, there won’t be any money left, so they need to manage the contents of the money bank carefully to ensure that the money bank is kept topped up.

So now one point to make very clear is that a trustee and beneficiary can also be one and the same. Now, and there’s usually more than one trustee. You can have up to four.

Robyn: So, Natalie, why are testamentary discretionary trusts becoming increasingly popular here in Australia?

Natalie: Several factors contribute to the growing popularity of the testamentary discretionary trust in Australia.

It’s an attractive way to hold assets as it provides an opportunity to effectively manage tax between family members. It can provide asset protection against creditors and family law proceedings, and it can easily pass assets on to the next generation. It can also assist families with vulnerable beneficiaries or help to provide guidance to those beneficiaries to ensure that their needs are always looked after, especially if they’re not good at managing money themselves.

Robyn: Yeah.

Natalie: So, the Jones family exemplifies this trend by using a testamentary discretionary trust to balance tax advantages with protection by distributing income among children and grandchildren, strategically, they can be smarter in turn preserving wealth for future generations.

Robyn: And what are the tax benefits of using a testamentary discretionary trust?

Natalie: So, a lawyer cannot provide taxation advice, but a testamentary discretionary trust is a well-known tool that can be used to tax plan.

By this I mean subject to the trust deed it may be possible for the trust income to be distributed effectively to beneficiaries on a lower marginal tax rates.

So, one of the best examples here is a distribution from a trust to a minor beneficiary, a minor as a beneficiary of a testamentary discretionary trust is entitled to an annual tax-free distribution. So, we always recommend a chat with professionals in this field such as accountants as they can provide key advice in this area when it comes to decision making for the distribution for effective tax purposes.

Robyn: And how do testamentary discretionary trusts protect assets and in turn protect beneficiaries?

Natalie: Okay. So, asset protection is a key feature of the testamentary discretionary trust. Firstly, what comes to mind is protection from creditors, so assets within the trust are generally not accessible to creditors of a beneficiary. Providing a shield in cases of bankruptcy or financial mismanagement. So, of course, this is not a blanket protection mechanism if that’s your estate planning goal, the structure you put in place needs to be discussed with an experienced estate planning lawyer.

The protective benefit of a testamentary discretionary trust is all in the structuring, which means individual legal advice for each circumstance.

Robyn: Yeah, sure.

Natalie: Next, I would say protection from potential family law disputes. In the event of a marital breakdown involving a beneficiary, the assets held within the testamentary discretionary trust can be excluded from the family law property settlement, ensuring that they remain within the intended family lineage.

So now this is a very specific estate planning goal, and the testamentary discretionary trust needs to be structured in a way to ensure the beneficiaries are best protected in this circumstance.

At the end of the day, the tools there to be used but ensuring the right structure is in place for the specific circumstances can mean the difference between the assets held within the trust being successfully protected or not.

Robyn: Okay.

Natalie: Finally, I would say the support it provides for vulnerable beneficiaries, so the structure within a will can provide essential support for those beneficiaries that need extra help, such as minors, beneficiaries with disabilities, spendthrifts and you know, the kids that just don’t seem to be able to get ahead in life.

Although suffering from substance abuse or generally just lacking financial interest, so the trustees can ensure that the funds are used appropriately and for the benefit of the beneficiary.

By the trustees controlling the distributions of assets, the more vulnerable beneficiaries will always have support to make that sensible financial decision making and be less at risk of squandering or losing their inheritance.

Robyn: Hmm. So how do testamentary discretionary trusts compare to, say, other estate planning tools?

Natalie: Comparatively speaking, a straightforward will is designed to appoint executors and legally pass assets to an identified beneficiary. It does the job it’s designed to do, but because of the way society has evolved, we’re seeing so many different family structures arise and by that I mean the days of the nuclear family with mum, dad and the two kids is not as prevalent as it used to be.

So, these days the new norm is increasingly becoming blended families, single parent families, families that have children that reside in overseas countries, families that are estranged.

The point is, society is evolving, and as it evolves family structures are too.

Robyn: Sure.

Natalie: So, if you overlay the different family structures that we’re working with and consider the wealth that’s been accumulated and passed through the generations, you quickly see that a straightforward will does not meet the needs of the family units we’re planning for.

So, everyone that walks through the door is a different case. Some will suit the straightforward will, but it’s becoming increasingly obvious that the straightforward will cannot meet the needs of all clients these days.

So, the testamentary discretionary trust can only be put in place by the testator. When the testator dies, so does the opportunity for the beneficiaries’ ability to be able to access the advantages that come with it.

So ultimately the testamentary discretionary trust provides the will maker with a lot more flexibility than other structures cannot provide. So this flexibility is important because we don’t know what’s around the corner and it’s always best to be prepared and have options available rather than to end up in the situation that would have, should have, could have.

Robyn: Yeah, of course. And in what scenarios are testamentary discretionary trusts particularly useful?

Natalie: Okay so testamentary discretionary trusts are highly versatile tools that can be tailored to encompass protection for young families, like ensuring assets can be managed to support the upbringing and education of the children.

They can provide a solution for second marriages or blended families to preserve inheritance. They can protect assets for high-risk beneficiaries and ensure that any loved ones facing financial difficulties can continue to be provided for, and ultimately what I love about them is the fact that if they’re not necessary at the time of death, the beneficiary can simply opt out.

Robyn: Okay. Well, they certainly sound like a tool everyone should be aware of, Natalie.

Now before we wrap up, what takeaway would you like to leave early listeners with.

Natalie: Well as estate planning lawyers, we have a lot of tools at our disposal to fit unique circumstances. At the end of the day, our goal is to put a legally effective plan in place that complies with the state’s laws and meet the legal requirements.

So, we also set our minds to the cost and efficiency of a plan as well.

If people realise the cost involved in correcting mistakes after death, or trying to resolve these complex family issues, they will realise the necessity.

So, I think as Australia witnesses this unprecedented transfer of wealth, testamentary discretionary trusts offer a forward-thinking approach to estate planning. They tick all the boxes in terms of what people want and need and they empower families to manage well strategically to ensure their legacy.

Robyn: Yeah, well, it seems like keeping up with the Joneses in the context of estate planning offers a lot of flexibility, control and protection for family legacies. Thanks for your time today, Natalie.

Natalie: Thanks for having me.

Robyn: You’ve been listening to law talks here on 4CRB, which you can hear every Friday morning from 9 o’clock.