When is it appropriate to make a testamentary trust in Australia?
Testamentary trusts are often used in a number of situations in Australia. Some reasons are there are assets that need protection when there is a potential for beneficiaries may be involved in future family law proceedings or be made bankrupt, to provide for children and disabled persons, to protect beneficiaries from themselves where they spend recklessly, gamblers, alcoholics or easily influenced by other people and for tax savings where income can be distributed through a trust.
Testamentary trusts and Australian probate laws
A testamentary trust in Australia that forms part of a Will can be challenged under Australian probate laws, especially where it benefits many but not necessarily benefiting anyone in particular or even if it is a fixed trust. It is therefore important to seek advice about the necessity of the testamentary trust when drafting your Will to ensure that the testator’s intention of conferring a benefit upon a beneficiary in his or her Will can be realised.
How to create a valid testamentary trust in Australia
There are three formal requirements to create a testamentary trust in Australia:
- The person who executes a formal deed of trust needs to show certainty in their intention to create a trust.
- There must be certainty of subject matter including the timing, amount of gifts disbursed and circumstances.
- There must be certainty as to the object of the trust and who are the beneficiaries. In this respect, an executor who can decide who are beneficiaries means that the testator did not exercise their testamentary power. There are some exceptions and legal advice should be sought, including where there is a gift to a defined class of persons or a valid charitable trust.
Testamentary trusts and their effectiveness in shielding from Family Law Act, Bankruptcy Act and Corporations Act proceedings
Specific legal advice should be sought to draft a testamentary trust in Australia where the intention is to effectively protect assets from proceedings in family law, bankruptcy, and corporate law. In this respect, a beneficiary of a non-exhaustive discretionary trust where the trustee has a discretion to distribute parts or no trust income would not have an interest in a trust except for any money or property paid or appropriated for his or her benefit by the trustees. But a beneficiary may have a proprietary interest in the income and assets of the trust if they effectively control the trustee of a discretionary trust. This has significant consequences as the property considered in proceedings of one party will form part of the property to be dealt with in family law, bankruptcy law or corporate law court proceedings. For example, a husband was the sole trustee and had absolute discretion to apply the income to himself as one of the eligible objects of the trust then the trust’s assets would be regarded as the husband’s property and be included for the purposes of property division proceedings. In addition, assets held in a fixed trust will mean the beneficiary has an equitable estate or interest in the estate property.
Testamentary trusts and pensions in Australia
A beneficiary may deprive themselves of pension entitlements and deprive other beneficiaries of income and capital if they are receiving income or capital from a fixed or discretionary testamentary trust. However, some beneficiaries may receives distributions from a trust without impacting their pension. For example, a special disability trust can be used to provide for the future care and accommodation of disabled persons if it is solely for the care and accommodation of the disabled beneficiary, the beneficiary is disabled as defined in law and the trust deed follows the statutory rules. When the beneficiary passes away, the trustee would then return the trust funds to the donor or to the nominated person. If the testamentary special disability trust fund is contained in a Will, it would return to the executor to be dealt with in accordance with the Will. It is important to note that capital and income is usually for the purchase of accommodation, payment of care costs and disability related expenses, not for daily expenses.
Taxation implications of testamentary trusts
There are capital gains tax implications which you should seek expert taxation advice. We work with a number of accountants who can provide specific tax advice.
Trustee powers in the testamentary trust deeds
Trustees need sufficient power to administer the testamentary trust deed including:
- lend money to beneficiaries with/without security and interest.
- distribute monies for maintenance, education, advancement or benefit of a beneficiary or their parental guardian
- give custody of real or personal property
- invest monies without liability
- lend or borrow money
- guarantee or indemnify others for payment of monies
- conduct business or trade
- open and operate any bank account
- to nominate third parties to hold assets in their name
- to charge or retain out of the Trust Fund such commission or other remuneration as is reasonable for a business or work done
- can exercise their powers when there is a potential to gain personally
- employ others including lawyers, accountants, admin staff, clerks, workmen, employees, contractors or agents to do things and pay them accordingly
A letter can be given to a trustee to set out the purpose and powers of the trust.
Who should you choose as a trustee in a testamentary trust?
A professional trustee such as a trustee company, lawyer or accountant can be appointed but they usually charge ongoing fees. Certain trustees may not carry out the testator’s wishes out of self-interest if they have a beneficial interest. In addition, an elderly widow may not have the skills required to manage a trust properly and being a trustee might impact on their pension entitlements where they are a potential beneficiary and they directly control the trust.
Life interests in testamentary trusts
A life interest is not desirable for long-term marriage or de facto relationship as the widow usually makes a claim for further provision for maintenance and support under the relevant state probate laws in Australia. However, where there are subsequent partners and children from an earlier relationships, it may be suitable to give a life interest where the spouse has sufficient assets of his or her own. The life tenant would have responsibility for maintenance, repairs and insurance on the property, except for major or structural repairs and drainage which is paid by the executor.
Limiting liability of the executor and trustees in administering the testamentary trusts
Executors and trustees cannot exclude themselves from fraud or intentional wrong doing or liability for gross negligence. This usually occurs when the executor or trustee acts without authority. They can be entitled to be indemnified out of the general estate for losses suffered if they do follow the testamentary trust. It is therefore important to draft the testamentary trust to include all potential powers that are needed to effectively manage the trust based on specific circumstances. For example, if there is a business that a trustee needs to manage then they should be given a power to do so.
The relationship between testamentary trusts and super funds
Superannuation funds are usually not included in the estate assets unless a valid binding nomination in the superannuation trust deed states the super funds are to be paid in the estate. The binding nomination should be renewed every three years to reflect the person’s current intentions. Superannuation death benefit payments paid to an estate specifically for the deceased’s dependent such as a spouse or children under 18 years of age is tax exempt. If the superannuation funds are paid to the estate, to maximise tax exemptions the testamentary trust should direct the superannuation benefits be paid to the testator’s dependents.
Need for successive trustees in testamentary trust deeds
Self-managed superannuation funds and family trusts should be checked to ensure that there is a continuing trustee or a successor trustee after the death of the testator. This can be through the existing appointor appointing a successor trustee, by an appointor appointed by the Will or by appointment by Will. The trust deed will need to be amended if there is no provision at all in the deed for a succeeding trustee either by appointing an appointor in the deed or by allowing for an appointment by Will.
Testamentary trusts and companies
Trustees can be a company and the testator’s shares should be disposed of in the Will. The company’s constitution should include succeeding directors after the death of the testator if they are a director. Company debts owed to the testator can be repaid by the estate, forgiven or bequeathed to a beneficiary. In addition, you should avoid gifting specific shares because where the shares change in substance such as another company taking over one company, will result in the failure of the gift by ademption rules, i.e. a gift of a specific piece of property fails if it does not exist at the time of the testator’s death.
Expert testamentary trust lawyers in Australia
Since 1989, our firm has been drafting testamentary trusts for clients throughout Australia. Please contact our office to discuss your Will and testamentary trust if you would like to make one.
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