Family trusts can use quirky tax rules
AN IMPORTANT INSTRUMENT IN A PLANNERS TOOLKIT
In the confines of a financial planner’s office, many secrets are revealed. It’s not just financial pipe-dreams and failed investments; family and concerns about how the next generation will receive the financial benefits of a life’s hard work often loom large. A financial planner often dusts out a family trust from the toolkit to help with these issues. A little-known quirk of the tax system means that for a deceased estate, trusts have significant add on benefits, particularly for minors.
A testamentary trust comes into existence when someone dies. Tax law dictates that for the first three years, the estate can continue to be taxed as though the individual is alive. Beyond that, the estate is effectively required to pay tax at the highest marginal rate — a good incentive to hurry things along and distribute the estate to beneficiaries.
If you draft a will that incorporates a trust deed, it can give you more flexibility. You might for example, decide to distribute your estate to your two children via two separate testamentary trusts. The trust will need a trustee, probably each of your children and beneficiaries. The beneficiaries may well be your children, grandchildren, great grandchildren and beyond but usually restricted to 80 years. The deed might give the trustee the discretion to distribute to the beneficiaries as they see fit.
If the trustees decide that the testamentary trust is not suitable, there’s nothing to stop them winding the trust up and distributing the assets to the beneficiaries.
The real benefit of a testamentary trust is where distributions are taxed in the hands of minors.
Let’s presume that on your passing, the proceeds of your estate pass to your single child and into a testamentary trust, naming your child and your infant grandchildren as beneficiaries. Had the money passed directly to the grandchildren, the income generated by their inheritance would effectively be taxed at the highest marginal tax rate. Distributions to minors from a testamentary trust allow them to be taxed in the same way as an adult, which means the first $18,200 in this financial year is tax free. This means income generated by the trust could pay for school fees and the cost of supporting the children until the trustee decides to change the arrangements.
There are other family law and bankruptcy protection benefits.
Testamentary trusts are a more powerful estate-planning tool than self-managed superannuation funds because there are not the same restrictions to getting access to funds.
However, testamentary trusts are complex and that means you don’t want to set one up on your own. You need services of a specialist estate-planning lawyer. And that investment — $1000 to $1500 — might be viewed as a one off insurance policy for the family fortune when you are gone.
© The West Australian