Estate Planning Explained (Part 6)

War Story 1

Karen’s son Paul had a drug habit. She left her estate to him on her death hoping he would use the money to undertake the drug rehabilitation programs he always promised to do. Paul tried the program for a couple of days and then dropped out using the estate to feed his habit. Karen could have left her estate ‘on trust’ for Paul – a trusted friend could hold Paul’s inheritance as trustee on behalf of Paul so that he did not have unsupervised access to the money but it would still be used to help him.

War Story 2

Mark’s Will left his entire estate to his only son, Eugene. Eugene had been a partner in a business that had gone sour and was on the verge of bankruptcy. When Mark died his estate went to Eugene in his own individual capacity and shortly thereafter, Eugene went bankrupt. The trustee in bankruptcy used the estate assets to pay Eugene’s creditors. Eugene didn’t see a cent of it.  This may have been prevented if Mark had set up a Testamentary Trust for Eugene to hold the assets in.

Did you know you can protect your family’s inheritance from unforeseen events, like those in the above war stories, and save tax through a Testamentary Trust?

Giving your assets to your beneficiaries in a Testamentary Trust can reduce the risk of diminishing or losing your family’s inheritance and provide protection to the inheritance should one of your beneficiaries get caught up in a divorce, be exposed to liability through business dealings, become bankrupt or have a gambling problem, etc.

What is a Testamentary Trust?

A Testamentary Trust is in essence a trust contained in a Will. A trust is simply a relationship whereby a trustee (the manager of the trust) holds money and assets for the benefit of another person or persons (beneficiaries).

Often a person will leave his/her estate to his or her partner, or if he or she dies before him, then equally to their children. An alternative is for the estate to be left to a trustee named in the Will, to be held on trust for his or her partner, children and children’s family. The trustee can be the same person that is intended to receive the inheritance, so that they are placed in control of the trust e.g. your adult child can be the primary beneficiary of their trust, as well as the trustee of the trust (so that they control & benefit from their own trust).

The trustee decides how to apply, distribute, reinvest and generally deal with the assets of the trust according to the circumstances at the time, rather than based on the Will maker’s direction at the time of making the Will.

Why should I set up a trust?

Establishing a Testamentary Trust can provide your beneficiaries with significant benefits – we explain three of these below, and will explain further benefits in our next article:

Protect your beneficiaries - secure their future

If you do not have confidence that a beneficiary will use the inheritance properly or may be too young - you can ensure they have the benefit of the inheritance without letting them have control over it.

A Testamentary Trust will ensure that the trustees have the power to apply the estate for the benefit of the individual, having regard to changing circumstances and laws.

If you wish, you may decide to specify an age at which that child can take control of their own inheritance or you can leave it to the discretion of the trustee.

Keeping your beneficiaries’ inheritance safe in bankruptcy and from commercial risk

A Testamentary Trust also provides protection where the beneficiary carries a commercial risk such as ownership of a small business where there is always a risk of loss.

If you have a beneficiary, such as a spouse or child, who is or may become bankrupt and you leave your estate to that beneficiary - the estate will go to the beneficiary and, in turn, into the hands of the Trustee in Bankruptcy - effectively the creditors will benefit from your estate.

A Testamentary Trust protects your estate as it will not be passed directly to the beneficiary but instead to your nominated trustees. The trustees will have the power to apply the benefit of the income and capital from the trust fund for the beneficiary, with the beneficiary retaining the power to change trustees from time to time. Once the threat of bankruptcy is removed the beneficiary can call for the distribution of the estate to him/her if he/she then wishes.

Keeping your beneficiaries’ inheritance safe in divorce

Divorce and relationship breakdowns are often unexpected and can result in a person losing a big chunk of their inheritance to their ex-spouse. However, a carefully drafted Testamentary Trust can assist to protect the inheritance. Family law is not straight forward, and the property orders will depend on a number of factors including when the inheritance was received and what contributions (both financial and non-financial) each party has brought to the relationship.

Although a trust may be regarded as a financial resource of the relationship and may have some effect on a property settlement, a Testamentary Trust can at least prevent the assets being disbursed by a Court and offers more protection than simply leaving the inheritance to the beneficiary in their own name.

If you’re thinking of having a Will prepared or needing to update an old one, please contact our experienced Estate Planning team to provide you further assistance.