Using a testamentary trust to protect assets and distribute income tax effectively
Helen is a widow with significant assets. Her adult son Leonard is married to Melinda, who has a son Jamie from her previous relationship. Leonard also has kids from his previous marriage: twins Hamish and Luca.
Helen does not get along with Melinda, and suspects that the marriage will not last. She wants all her assets to go to Leonard and then to her blood grandchildren only upon her death.
The “do nothing” scenario
Helen leaves all the assets in her estate to Leonard directly. Leonard uses the majority of his inheritance to repay the mortgage on his home, jointly owned with Melinda. He then invests the remaining funds. Leonard pays tax at his marginal tax rate on all investment income. If Leonard transfers any of the capital to his minor children, penalty tax rates will apply to the income the children will derive.
Five years later, Melinda and Leonard divorce. The Family Court orders Melinda and Jamie to receive the family home and a large portion of Leonard’s other assets. As a result, a large portion of Leonard’s inheritance ends up in the hands of Melinda and Jamie, rather than Helen’s grandchildren.
An alternative scenario
After consultation with Helen, we identified asset protection as a concern and explained the risks of the “do nothing” approach. We recommended Helen seek legal advice, and to consider including a testamentary trust in her will to protect her assets against the risks of Leonard’s marriage breaking down.
Ultimately, Helen established a testamentary trust in her will, with Leonard, Hamish and Luca nominated as beneficiaries. To increase certainty that Helen’s wishes were carried out, the solicitor recommended appointing another trustee to act jointly with Leonard.
As a result of this strategy, upon Helen’s death, the income and capital can be distributed to Leonard and her grandchildren. Grandchildren will be taxed at adult rates on the income distributions, which results in a much more favourable tax outcome.
If Leonard and Melinda were to divorce, the Family Court is unlikely to treat the assets of the testamentary trust as Leonard’s own assets. Therefore, Helen’s accumulated assets will be protected and preserved for her son and her blood grandchildren.
* Names have been changed to protect client privacy.
What to do next:
If you'd like to help you with estate planning, please contact us today on 03 8394 0300 or email us at email@example.com to organise a time to meet with one of our Certified Financial PlannersTM.
Paying off your mortgage sooner and building your wealth
You are thinking about retirement, still have a mortgage, and not sure if you have enough savings