Testamentary Discretionary Trusts
Any trust established by a will is called a testamentary trust. Indeed, a will itself is a form of trust regardless of its simplicity or complexity. Testamentary Discretionary Trusts (TDTs) are a type of testamentary trust that are increasing in popularity, and which are effectively a discretionary trust (similar to a family trust or a trust set up during a person's lifetime) established under a will. TDTs can be very flexible structures and can be customised to suit the objectives and needs of the individual or family in question. Although there are both taxation and asset protection advantages associated with a TDT, the taxation advantages should be regarded as secondary to the asset protection advantages.
TDTs can offer some asset protection against divorce or a relationship breakdown and bankruptcy for subsequent generations on the proviso that they are carefully drafted. Beneficiaries of TDTs can be a very wide class of people or other entities, or can be limited to "direct descendants" of the will-maker. They may also distinguish between which beneficiaries can receive distributions of capital and which beneficiaries can receive distributions of income. For example, the entitlement to receive distributions of capital can be limited to just direct descendants, whereas other beneficiaries (including in-laws) may be entitled to receive distributions of income. TDTs help to protect assets from the reach of a trustee in bankruptcy or from the Family Court. If the trust is properly structured and carefully planned, none of the beneficiaries has an absolute entitlement to capital or income, and for a trustee in bankruptcy or the Family Court to say otherwise would then impact on the rights of other potential beneficiaries.
Generally speaking, it is the trustee or trustees of the TDT that are given the discretion to decide which of the beneficiaries receive distributions of capital and which of the beneficiaries receive distributions of income. The appointment of suitable and appropriate trustees is very important, and careful consideration needs to be given to this. More than one trustee can be appointed, and the appointment of "backup" trustees is desirable particularly as the TDT can continue for many years after the will-maker dies. Possible trustees include one or more of the will-maker's spouse, adult children (whether individually or as a group), a trusted family adviser (perhaps an accountant/financial planner/lawyer), private trustee companies and others. It is often
desirable to include as a co-trustee a person or people who are not beneficiaries, and who are therefore seen to be "independent". This is particularly the case if there is a concern over a child's ability to manage the trust or manage it in the way that the will-maker had intended. TDTs do offer flexibility in their control. A number of separate TDTs can be established under a will, with each particular trust being essentially for the benefit of a particular beneficiary or child and that person's direct family members.
It is often sensible and desirable to supplement the will with a separate and confidential Memorandum of Directions/Wishes. A Memorandum of Directions/Wishes invariably includes private information for the benefit of the trustees, including information as to why the will was prepared in the way it was, how the will-maker would like to see the TDTs administered, and the will-maker's wishes in relation to the benefits that particular beneficiaries receive (this is particularly relevant with non-cash assets such as real estate). If the private and often very personal information that is contained in the Memorandum was included in the will, it is then possible that information will become generally available to the public (and more particularly to beneficiaries) through the process of obtaining a Grant of Probate of the will, or by the beneficiary in question reading the will. It is important to realise that the information contained in such a private document is not legally binding on the trustees and only represents the will-maker's wishes. However, generally speaking, the will-maker will presumably have the comfort and assurance that to the fullest extent possible, the trustees will endeavour to carry out the will-maker's wishes.
The main taxation advantage is found in sections 102AE and 102AG of the Income Tax Assessment Act 1936. In summary, income distributed to infants from a TDT is taxed at the ordinary marginal tax rates, so long as this income is being distributed to benefit the infant (whether in the nature of payment of school fees, expenses associated with the provision of food, clothing, sporting equipment, and so on). By way of contrast, if a family trust set up by a person during that person's lifetime makes distributions to infants, those distributions generally attract the highest marginal tax rate (about 45 percent).
We emphasise that TDTs should not be used solely for taxation purposes. The aim should always be to ensure that the most appropriate estate plan is put in place - one which hopefully offers the best protection for all concerned.
For more information about Testamentary Discretionary Trusts, please contact HopgoodGanim’s Estate Planning and Administration specialists.