Parents who have built significant wealth worry less about tax than about what happens to it next. A son marries and divorces within five years. A daughter’s business fails. A grandson in his twenties receives $10 million and no guidance. In each case, an inheritance left outright becomes part of that person’s property, and is exposed to everything that happens to them.
The risks
- Divorce. In an Australian family law property settlement, an inheritance received during or even after the relationship can be included in the property pool, depending on the circumstances. Inheritances in other countries may be treated similarly.
- Creditors and bankruptcy. Assets owned outright by a beneficiary are available to their creditors.
- Immaturity, vulnerability or influence. A young or vulnerable beneficiary may be pressured by a partner, friends or advisers.
- Tax. Income earned on an outright inheritance is taxed at the beneficiary’s own marginal rate.
The tools
- Testamentary discretionary trusts. The inheritance is held in a trust created by the will. The trustee can distribute income and capital among a class of beneficiaries, which gives flexibility and some protection. In Australia, income distributed to minor beneficiaries of a testamentary trust is generally taxed at adult rates.
- Choosing the trustee and appointor carefully. Protection depends on who controls the trust. If the heir controls it alone, a family court may treat its assets as theirs.
- Protective trusts for a beneficiary who needs ongoing support, with an independent trustee.
- Staged distributions: capital released at set ages or milestones.
- Binding financial agreements, which the heir makes with their partner before or during the relationship, recording that family inheritances remain separate. These require independent legal advice for each party.
- Family constitutions and letters of wishes to explain the purpose of the wealth to the next generation.
A note on expectations
No structure is absolutely protected. Courts look at substance as well as form. The right structure, properly run and combined with good communication, makes protection far more likely.
Frequently asked questions
Is an inheritance protected in a divorce in Australia?
Not automatically. In an Australian family law property settlement, an inheritance received during or even after the relationship can be included in the property pool, depending on the circumstances. An inheritance left outright becomes part of the heir’s own property and is exposed to a later separation, which is why many parents choose to leave wealth in a trust instead.
How does a testamentary trust protect an inheritance?
A testamentary trust holds the inheritance in a trust created by the will instead of giving it to the beneficiary outright. The trustee can distribute income and capital among a class of beneficiaries, which gives flexibility and some protection. The protection depends on who controls the trust: if the heir controls it alone, a family court may treat its assets as theirs.
Can a binding financial agreement protect a family inheritance?
It can help. A binding financial agreement is made by the heir with their partner, before or during the relationship, and can record that family inheritances remain separate. Each party must receive independent legal advice. It is usually most effective as one part of a wider plan that also uses well-structured trusts.
Can an inheritance be completely protected from creditors and divorce?
No structure is absolutely protected, because courts look at substance as well as form. Assets owned outright by a beneficiary are available to their creditors, while assets held in a properly structured trust are much harder to reach. The right structure, properly run and combined with good communication with the next generation, makes protection far more likely.
Chua Tan Associates advises families, executors, trustees and their professional advisers on estate planning, estate administration and estate disputes, in Australia and across borders. To arrange a confidential consultation, please contact our Melbourne office on +61 3 9602 3988 or submit an enquiry. Advice is available in English, Mandarin and Cantonese.
Justin Chua (蔡智勋), lawyer and mediator, Chua Tan Associates, Melbourne. General information only, not legal advice. Victorian law unless stated otherwise.
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