Opinion

Trusts that will cut tax and keep wealth in the family

Testamentary discretionary trusts are a good way to transfer wealth between generations in a tax-effective way and protect assets from relationship breakdowns.

Michael HuttonContributor

Dec 6, 2021 – 5.00am

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As Benjamin Franklin famously said, “nothing is certain except death and taxes”. While there’s not much that can be done about death, with some careful estate planning it is possible to reduce the tax burden for beneficiaries.

Even though there is no official “death duty” in Australia, tax certainly pervades many aspects of the distribution of an estate. The way distributions to beneficiaries are structured is of paramount importance.

The first step in good estate planning is to make sure all documentation (such as a will, superannuation nomination, etc) accurately records who assets should go to.

The second step is to set this up in a tax-efficient manner. An increasingly popular approach is to use a testamentary discretionary trust as part of an estate plan.

Testamentary discretionary trusts are an attractive structure for passing on wealth tax effectively, and can help ringfence and protect any inheritance. They’re different from a more regular family discretionary trust in that they only come into existence after the death of the person who sets them up. It is therefore something that needs to be planned in a will – it can’t be retrofitted later.

Rather than leave assets directly to beneficiaries in the will, people instead specify that a testamentary discretionary trust is to be formed. The assets, or cash proceeds from sale of assets, are transferred to the trust for the beneficiaries to then retain or invest. The terms of who controls and benefits from the trust are also recorded in the will.

Because the assets being transferred in the trust are not subject to capital gains tax at this point, it is a very tax-effective way to bequeath assets. If they are later sold, however, tax will be payable on capital gains generated. As long as the person making the will acquired the assets after September 1985, the gain is calculated based on the cost of the asset to the will-maker.

Another way that testamentary discretionary trusts are tax-effective is that because the trust is discretionary, distributions of income can be split among family members, similar to a family discretionary trust. However, unlike a family trust, if this trust distributes income to a minor (under 18) that person qualifies for adult marginal tax rates. Such trusts can therefore become excellent investment structures for beneficiaries well into the future.

Asset protection benefits

One potential downside to keep in mind is that, while capital can be added to these trusts, the tax concession for minors only applies to income from the assets that came from the estate. Normal tax rules apply to income derived from other, non-estate assets that are later added to the trust.

There are other advantages to testamentary discretionary trusts, outside the tax considerations. Assets held within them can provide asset protection benefits for beneficiaries from creditors or relationship breakdowns. This is because the assets are held by a trustee in trust for the individual, not held personally by the beneficiary.

Like discretionary family trusts, these trusts typically last for a maximum of 80 years and, upon death of the principal beneficiary, control of the trust could be passed to their chosen beneficiaries, so everything is kept intact.

Another option upon death of primary beneficiaries is to sell the assets and transfer the proceeds, or transfer the assets in specie, to a new testamentary discretionary trust established for their own beneficiaries. This would need to be appropriately allowed for in estate planning documentation. This sets up a new testamentary discretionary trust to use as an investment structure, which may be a useful option. Selling or transferring assets would trigger CGT, however, so this needs to be taken into account.

Michael Hutton is wealth management partner at HLB Mann Judd Sydney.