My Last Will and Testament
by Mark Causer
The idea or concept of a last will and testament is one that dates back to ancient Rome.
Throughout history there have been pivotal individuals responsible for great change and advancement in our society. The development of our current law is no exception. A lot is owed to a man named Solon, in relation to the ability to choose how we want our property distributed when we pass.
Solon was a reformer statesman in ancient Athens, Greece, who lived before Christ. The law before his time was attributed to another Greek leader, Draco, but that law was exceedingly harsh and severe, hence the word draconian. Solon determined to make the law more reasonable. For instance, before his change of the law, a person had to leave his estate exclusively to family members.
With Solon’s new laws, others could be beneficiaries of a will. As the historian Plutarch reports, Solon “thus put every man’s estate in the disposal of the possessor.” Well, almost. A man could leave property to others only if he had no sons; if he had only daughters, those men to whom he left his property had to marry his daughters!
Rome followed Greece. The intent in Roman law was that a man could make his own disposition of his estate by a will, but the prime purpose of inheritance remained the preservation of the family, and family inheritance was strongly favored.
Times have changed, but the principal fundamentals have not and ensuring that each and every one has a valid will remains a key plank to ensuring your financial affairs are in order. It should also be a key tool in all advisory tool bags.
A typical question that an adviser might ask a new client as part of the ‘fact find’ process is;
“Do you have a will” and
“When it was last updated”
It could be really simple to assume that all wills are ‘standard’ and if a will is in place and is current, then TICK, all is good.
Sadly this assumption may result in the loss of thousands of dollars in wasted taxation payments.
A will is one part of the estate planning process. The adviser and solicitor work together to develop a strategy to deal with their client’s assets after they die, the legal instruments and structures, such as a will, should allow for the transfer of your assets in the event of death.
We have delivered many presentations on estate planning and wills and why they are important. Upon announcing the subject matter you do notice the shoulders of many of the audience start to droop and the yawning begins!
In this newsletter, we go straight to the concept of a Testamentary Trust and why it is important that you all consider this vehicle as an option inside your will.
Testamentary Trusts have been used in wills for a very long time.
A Testamentary Trust (TT) put simply is a trust that is established after a person dies, to hold assets for the benefit of the beneficiary(s). Instead of the beneficiary receiving assets directly from the estate in their own name, the assets go into a TT controlled by an appointed individual known as the Trustee.
This may be beneficial for a number of reasons, including:
taxation minimisation, especially when distributing to minors
protection of estate assets against creditors
protection of estate assets from a relationship breakdown
Using a TT within a will can allow greater control of the assets when they're distributed to the beneficiaries. It can also provide taxation advantages and protect the assets in certain situations.
So how does a Testamentary Trust operate?
The TT is not physically established when the will is done, it's established when the individual dies. The will gives the executor the option or direction to establish the trust upon the will maker's death.
The TT operates similarly to other trust structures, in that there is a trustee and beneficiaries. One benefit of a TT is that beneficiaries under the age of 18 (i.e. your young children or even younger grandchildren) are taxed as adults rather than minors on any income paid from the trust.
Higher tax rates (45% of total income if the income is more than $1,307 derived - or 66% for income between $416 and $1,306) can apply to minors on what is called ‘unearned (investment) income’. If however they are taxed as adults, distributions (of income) paid via a TT, the tax is materially reduced.
So the obvious strategy is that you can split the income among younger family members (maybe even the broader family group) and by reducing taxes, this will result in a greater capital sum for the beneficiaries and may result in the inheritance lasting a lot longer.
Trust tax example
Uncle Bruce has recently died and his estate has $2.5 million in cash that he wishes to leave to you, his adult son.
You have a non-working spouse and two children, aged 8 and 10 years.
You earn $180,000 pa in income, so you're in the top marginal tax rate.
If you were to receive the $2.5 million inheritance directly and invested it in cash (as you might be a conservative investor) at say 2% pa, this will earn interest of $50,000.
Accordingly you would pay tax of $22,500 plus Medicare Levy of $1,000 - $23,500. There is also NO growth on your investment.
If however, your uncle left his assets to you by way of a TT with your family as beneficiaries, the $2.5 million in the trust which has earnt $50,000, could be distributed equally to your spouse and two children - $16,667 EACH.
In this example, there would be NO tax payable on the earnings as each person receives $16,667 which is UNDER the adult tax-free threshold.
Therefore, by using a testamentary trust, the family would save tax of $23,500 for each year. Over a ten year period, that is as much as $235,000 which could generate more returns and preserve the original capital value for a longer period.
Your young children will not be young forever. Fast forward 20 years and they will likely have young families of their own. They can include THEIR children into this same strategy and the tax advantages continue and grow.
If the TT is invested for the longer term, it would be expected that the investment rate of return would be much higher, causing the tax advantages to increase.
In today’s modern world, many young couple are burdened with a mortgage, school fees and the simple cost of living. If they receive an inheritance, it would be very easy to tax the lump sum and spend it!
Importantly, a TT can give the trustee choice as to when and how beneficiaries receive their estate proceeds. So YES, lump sums can be accessed.
For example, you are a beneficiary needing $300,000 to repay your mortgage. A TT can be structured to allow a capital distribution from the trust, or a loan from the trust. You could then use this money to repay your mortgage, reducing the reliance on banks.
This ‘loan’ can then be repaid back to the TT (over time at your convenience), to then be reinvested and the very same tax advantages recommence.
A final point of note for a TT, is the asset protection that is provided.
Using a different example, let’s say you run your own business which is having financial trouble and it looks as though you may have to liquidate it and declare bankruptcy.
If you were to receive the $2.5 million directly, this money would potentially be available to the creditors, meaning your uncle Bruce’s estate could be paying for your failed business.
If this money was left to a testamentary trust, the money is not legally owned by you. This would make it more difficult for creditors to get access to any lump sums from the estate.
Another example to consider might be you are married with no children. You're having relationship issues with your spouse and are looking at getting a divorce. Your uncle dies and you receive $2.5 million.
This inheritance could now form part of the financial assets looked at for divorce settlement. If the inheritance was segregated into a trust, it may remove the estate proceeds from the financial settlement of the divorce, protecting your uncle’s wishes.
Similarly, a young adult enters into a marriage, unfortunately the marriage lasts for say 2 years only, the very same outcome as stated above may play out. The TT provides an additional layer of protection and access to the original capital.
Everybody is different and no one size fits all. It is therefore important to explore your options to ensure that your existing estate planning strategies and your will are both aligned.
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