Tara (00:48):
Hello, hello, hello. Thank you again for joining me. I am Tara Lucke, founder of the Art of Estate Planning. I'm thrilled that you are listening to me in your ears.
(01:02):
Again, today's episode is going right back to basics to talk about what is a trust. Now, it does occur to me that I probably should have started the podcast with a topic like this instead of leaving it to over a year into the podcast life, but it is what it is and better late than never. So I wanted to just go back to some core foundational principles because in a lot of our episodes we just dive straight into the heavy topic, but I thought, why don't we actually just make sure we're all on the same page and start with the basics about what is a trust, especially if, let's face it, we probably all covered trusts at uni. We know that trusts are around, we use them in our practise area, but unless you are a tax or equity or estate planning specialist, you may only have a very high level working knowledge of a trust.
(02:09):
So I wanted to try and demystify them a little bit, remove some of the uncertainty, the nervousness around trust, because I think it can be an area where a lot of people do feel a little bit nervous or not trusting that they truly know the ins and outs. So because at the art of estate planning, a core part of our service is providing testamentary trust will precedents, we are looking at trust all day, every day inside out. And a lot of this podcast is about testamentary trust, and I want to make it totally clear that a testamentary trust is simply a trust set up in a will, which starts on death, but it has the same core features as trust set up during a person's lifetime and all the other types of trusts, they all share common fundamental features. So let's talk through them. The first thing is that a trust is really a relationship that has essential elements to it, and there's four essential elements.
(03:19):
You need a trustee, you need trust, property beneficiaries and trust terms. And for me, I like to think of it as the key feature of a trust arrangement is that we have a separation of who is in control of the trust property and who can benefit from the trust property. Now, I do want to just say I'm talking about trust property. I'm using that term, and that is something that differs when it comes to testamentary trust versus a trust set up during a person's lifetime. And by the way, I'm doing sidebars on top of sidebars here, but if you've heard of the phrase vials trust, that just means a trust set up during a person's lifetime. So testamentary trust is a trust that is enlivened on a person's death. IVs is a trust set up during a person's lifetime. So if I was to go and set up a family trust tomorrow, that is an inter-vivoss trust.
(04:30):
Now with a inter-vivos trust, a family trust, if I'm going to go set that up tomorrow, we need someone to be the setter law and the setter law contributes the initial trust property over which the trust arrangement operates into the trust. So in common practise, the settle law is usually a arm's length third party who has no ongoing connection with the trust, and it's very common for them to just settle $10 as the initial trust property and then the trustee or other people closely connected to the trust contribute more assets to constitute the trust property into the trust over time. Now, it's so weird this settle on notion and being $10, $10 is just a nominal amount that became industry standard. It's not legislated anywhere. I think it's probably derived from stamp duty requirements, perhaps back when you might've had to pay stamp duty on getting the trust deed stamped perhaps based on the trust property or if there is a duty bowl event on the creation of a trust or a taxing event on the creation of a trust and you're like, well, we're only creating it over $10.
(05:56):
So any stamp duty or CGT is nominal. So that's sort of the origin of that. You also, in Australia our trust, you can't have them as revocable. So you'll see in any trust deed, the settle law can never get a benefit. It will always say the settler law cannot be a beneficiary as well as the settler's spouse or children, and there's always that exclusion that is actually reflective of section 102 of the revocable trusts section in the Income Tax Assessment Act 1936, where basically the trust is void from the beginning if there's a way for the settle law to benefit. So that's why we have that there. If you are thinking of revocable trust, if you've come across that phrase that is a uniquely American phrase, it actually might be in other jurisdictions, but usually where you see it coming up, if it's on social media or YouTube or videos where a probate lawyer is saying you need a revocable trust to avoid probate, that's an entirely American concept, nothing to do with Australia.
(07:07):
In Australia, the settle law cannot benefit. The trust has to be irrevocable once the property is gifted into the trust, that's it. No recourse to the settle law. So that's how this inter-vivos works in relation to the trust property, getting into the trust with testamentary trust, you don't have a settle law. The test data is sort of the notional settle law. They're not called a settle law per se in the documentation, but it is the test data who is gifting the assets, the inheritance into the test testamentary trust comprising the initial trust property. So I just wanted to mention that in terms of that trust property element, that does just differ a little bit depending on if we're talking about a family trust or a vivos trust or a testamentary trust. So back to our core feature of trust is the separation of control of the assets or trust property from the right to benefit.
(08:11):
And this feature is common in all kinds of trusts, family trusts, discretionary trusts, sort of the family trust is a colloquial term for discretionary trusts that you see used in practise, unit trusts, self-managed super funds, which are a type of trust, testamentary, trust, fair trusts, fixed trusts, all of those trusts have this feature. I also just want to go on a little side note. There is a lot of terminology around trusts and a lot of it is just pure marketing. You see things like bloodline trusts, lineal descendant trusts, three generation trusts, capital protected trusts, all of those terms. I'm actually just looking at some websites that I collected together for our online course, testamentary Trust, the Essential Guide for Australian Lawyers. I'd sort of put this together to guide our members through navigating this, especially when they get inquiries from clients going, I need a bloodline trust, I need a capital protected trust.
(09:19):
And it's only because they've been reading some marketing on the websites of different providers that they are coming to you with this terminology. All of it is just smart terminology and marketing strategies to explain a trust. It doesn't really mean anything. We've got to go back to the core and really the core thing comes down to the entitlements of the beneficiaries. Are they at the discretion of the trustee or are they set out in the deed with certainty as well as the range of beneficiary who's entitled to benefit? So like a bloodline trust is the same as a lineal descendant trust where what? It's just a phrase to describe where spouses of the beneficiaries are not included as eligible beneficiaries of the trust. We're just keeping it to lineal descendants. I will just say don't use the phrase bloodline trust in any of your materials or marketing.
(10:25):
I think a lot of people know this now, but a Brisbane law firm, Cleary whore actually has a trademark registered over that and they will enforce it. So I think lineal descendant is probably not as clear as bloodline, but that is a term you can freely use. Just be careful with bloodline. Okay, we're on a tangent. So let's go back to the core feature of all of these trusts separating control from the right to benefit. If you get one thing out of this episode today, it's that a trust. The fundamental feature is that we're separating the control from the right to benefit. So the initial controller is the trustee. The trustee has the legal control of the trust property. They're responsible for the day-to-day management of the trust property. They are the legal registered owner of any assets, like if you're thinking about a property owned by the trust, the titles registry will have the trustee as the owner.
(11:32):
If you're talking about shares, ASIC will show the trustee registered as the owner and the trustee has certain responsibilities to manage the trust for the benefits of the beneficiaries in their best interests. It is actually a role that is a fiduciary role, and they have a number fiduciary duties in their role. So it is a very serious role. The trustee runs the trust for the beneficiaries. There are other controllers that may or may not be optional. You always need a trustee. You may have an appointor, a principal, a guardian. Those are optional roles and it will depend on the particular terms of the trustee, whether they're in there. So typically an appointor or a principal will have the power to unilaterally change the trustee, which makes them a really powerful role. They might often have consent roles as well where certain powers of the trustee can only be exercised with the consent of the appointer or the principal.
(12:38):
Appointer or principal usually means the same thing. It's just a preference of the drafter as to what phrase they use. Also, you might see a role of guardian. It might be instead of or as well as appointor or principal. And again, its powers will really depend. So you might see a guardian role in a deed and especially if it's there alongside a principal or an appointor, then often it will just have a consent function to consent to different things or super decisions. But it always depends on the dead. You really cannot make any assumptions on what powers will attach to those roles. You also can't make any assumptions about the powers that a trustee has because they are a fiduciary. They need express powers written into the trust terms for them to act and take action in relation to the trust property. And if there is no express power to do a particular action, the trustee can't do it.
(13:40):
Now let's talk about the beneficiaries. So the beneficiaries are the people who are entitled to benefit from the trust. So typically it will set out their entitlement to income and their entitlement to capital. Now, I'm sure most of you know this, but in case you haven't looked at this concept for a while, when we're talking about the distinction between income and capital, think I like to visualise of an apple tree. So the tree itself is the capital, the trust property, and each year that tree generates fruit. So people come along, the farmer picks the apple off the tree. The apple, the fruit is the income it's generated each year from the underlying capital base. So you typically would just keep the capital in its form and then collect the fruit, harvest that fruit, take the income each year. But if you maintain the capital, it will keep generating the income for you.
(14:50):
If you into the capital and take that capital and go and spend it on a holiday or something that's not income producing, then next year you're not going to have as much income generated. If one year the farmer decides he actually needs to cut down most of that tree to use as firewood, then next year there's not going to be any apples. Is there no income? So depending on the terms of the trust, and this is one of the distinctions about the different types of trust. The way that we classify the trust will depend on how the beneficiaries entitlements to income and or capital are set up. Now in a discretionary trust, when I'm talking about family trusts, testamentary trusts, usually what we're referring to is a discretionary trust. So the entitlements of the beneficiaries are purely at the discretion of the trustee. The trustee can pick and choose out of those beneficiaries who receives a benefit, how much and when, and whether it's of income or capital.
(16:00):
The beneficiaries cannot put up their hand and demand a distribution. They only have a right to be considered for due administration of the trust and for the trustee to give real and genuine consideration to their needs. When the trustee decides which of the beneficiaries do receive a benefit. So the beneficiaries themselves cannot be said to own any of the particular trust assets. They only have certainty about their entitlement in the trust after the trustee has exercised their discretion and made a resolution to distribute in that particular beneficiary's favour. Until that point, until the trustee exercises their discretion in their behalf, that beneficiary or each beneficiary has an interest that is somewhere between 0% and a hundred percent. So we cannot ever say with certainty what that beneficiary is going to receive. So that actually sounds kind of scary, but it really depends on how the trust is structured.
(17:04):
So if you do have a trustee who is on arms length, a third party to the beneficiaries, then that's exactly the case. The beneficiaries are just sort of sitting there going, please sir, may I have some more and waiting for the trustee to decide whether they will bestow a distribution in their favour, but I will explain it in another way where it's closely held. So for instance, I run the Art of Estate Planning through a trust and the trustee of the trust is the Art of Estate Planning Proprietary Limited, and I am the sole director. The trust is set up with a very broad range of beneficiaries. It's got myself, my husband, our children, our future lineal descendants, our respective parents, siblings, aunts, uncles, cousins, nieces, nephews, our other trusts and companies, any charities. We nominate a very broad range of beneficiaries. But at the end of the day, I am the controller of the trust.
(18:08):
I'm the appointor and I am the sole director of the corporate trustee. So I'm not feeling nervous about who's going to benefit from the income and capital of the trust because I'm in charge. I'm one of the beneficiaries if I want to, I can give all of the income and all of the capital to myself. So day to day the trust that I run my business from looks and feels like my assets. I know there's a trust arrangement there. I've got the compliance of a trust when I do my tax return and the benefits of the trust. But I'm not worried about this separation of control and the right to benefit because I'm in control. But if someone like a third party who I didn't have influence over was the trustee, then I'd be seriously worried because I'm working day in, day out growing the business and I've got no certainty whatsoever about whether I will ultimately benefit from that.
(19:16):
Sometimes analogies can be helpful for each of us and also for our clients in terms of explaining a trust. So in terms of explaining like an intero trust, here's some analogies that I like. The first one is a library. So imagine the library. Initially the library was created where the settle law donated and may perhaps books or bestowed a big cash gift onto the library. You then have the head librarian, let's say that their role is akin to the trustee. So the librarian decides how many books they're going to buy, which books, and it sets up the framework on how people can access the books. The beneficiaries are like the members of the library who come and they get to borrow and access the books that the trustee decides they're allowed to borrow. So the trustee decides who's eligible to borrow. It's probably a modern library is a little bit less.
(20:27):
The librarian's not approving every single borrower, but the beneficiaries don't have access to the books. They get the enjoyment of the books. They can't sell them, alter them, make any decisions to the books. They can't choose to buy new books, they just get access. It's the trustee and the librarian manages all of the books and the library. Another one is a bit like a picnic basket. So say the picnic basket is packed and then you go on a picnic and I'm there with my children, I open up the picnic basket, I'm the trustee, I'm in control. I've carried the picnic basket the whole way to the picnic and I'm going to have a look at what's in there and my children are the beneficiaries. So I will decide, okay, I can see sandwiches, cake, and poppers. So I want the kids to eat the sandwiches first so they will just get access to the sandwiches.
(21:29):
So I'm giving them the sandwiches. The kids don't have any control over what's in the picnic basket. They are really, whether they have lunch at all is completely at my discretion as control of the picnic basket and they just get the benefit. So some of those analogies might find useful in terms of separating the right to benefit from the control. Now a few other things I wanted to just touch on is a reminder about why go through all of this effort to create the arrangement where we're separating control and the right to benefit to establish a trust. There's several benefits. I think probably the four main benefits are the tax flexibility, the asset protection, the ability to protect financially immature beneficiaries, and the ability to rule from the grave. So just very briefly on the tax flexibility, because the assets and the income generated from the assets in the trust do not belong to any one of the beneficiaries, the trustee can optimise all of the beneficiaries marginal tax rates each year to allocate the income amongst the beneficiaries.
(22:54):
So I'll use myself as an example again with the inter-vivos trust and I'm running the art of estate planning business. If I was running that business just in my own name as a sole trader, then I would have to pay tax on all of the income that the business earned and I'd probably be paying that at 47, 49.5% because we are running it through a family trust. The trust is a flow through vehicle for trust for tax purposes. So it doesn't get taxed as its own entity, unlike a company would. What you actually have to do is follow through the income to look at the ultimate recipients and the income gets taxed at the ultimate recipient's marginal tax rate on top of their other tax. We actually discussed this in a lot more detail in a testamentary trust sense in episode 45 if you want to go through there because I spent a whole 45 minutes talking and deep diving into it.
(24:08):
But back to the analogy, because I'm running the business through the art of estate planning trust, I can choose, okay, I'm going to distribute a certain amount of income to myself, but I'm going to do it. So my tax rate is capped at the 30 percent-ish mark, my husband has been at home doing his PhD, he's finished that now, thank God. But he did that for seven years. So I could, if I wanted to allocate part of the income from the business profits to him, use up his tax rate. If you've got other family members, you can do that. The big difference, which I talked about in episode 45 between an inter-vivos family trust and a testamentary trust is how children and minors are dealt with. So with a testamentary trust, children can get up to 22,000 tax free with an antivirus trust it's $416 tax free and then penalty rates thereafter.
(25:11):
You can also distribute it to a company and cap it at the corporate beneficiary rate as well. You just have a lot of flexibility and freedom. If I wanted to keep things super simple, I still could give all the income to myself from the family trust. It doesn't have to be spread out amongst family members, but you have the choice and the flexibility to optimise the everyone's tax rates in your family group. That ability is hinging on the fact that the entitlements of the beneficiaries are discretionary. So if you have a fixed or a unit trust where there is no discretion and there's more certainty about the entitlements of the beneficiaries, you don't have that same flexibility. It's the discretionary nature of the beneficiaries, entitlements and the trust that really create the tax benefits. And the same for asset protection. So when we're talking asset protection, two of the main risks we're talking about are a beneficiary of the trust going through a bankruptcy or insolvency process and then also going through a family law property settlement as a result of a relationship breakdown.
(26:30):
And in both of those cases, what we want to make sure is that where there's a claim against an individual beneficiary that the assets in the trust are not available to satisfy that claim. And the trust certainly help with that because of this argument, like I said earlier, that the entitlements of the beneficiary is going to be somewhere between zero and 100% and they have no entitlement or claim on the assets of the trust until and unless the trustee exercises their discretion in their favour. So when people say, oh, I want to trust, I want all the protection benefits, but I'm nervous about the separation between control and the right to benefit and the uncertainty that brings, can we make that certain that decision to create certainty and set or fix the entitlements of the beneficiaries removes the income tax and asset protection advantages? You need the uncertainty and their complete discretion of beneficiary entitlements to achieve the asset protection and tax.
(27:46):
So what we do in practise is just make sure that we get the controllers right, we have the right checks and balances and the right people nominated as trustees, appointor principles, guardians, so that we have the inbuilt protection. Now the other benefits are again, just protecting people who are not financially mature to manage assets on their own, whether that's just because they're minors and under 18 and they legally can't or they're young adults and not sophisticated enough. Or if they do have disabilities or need more protection, then a trust allows. We can still have people benefiting. The money goes to the people who need it, but the people in charge trusted individuals. Also, the same with the ability to rule from the grave. If one person really does want to hang on and set up a whole framework about how this asset and money is controlled, then a trust can do that too.
(28:48):
Now I've mentioned throughout here the trust deed and one of the essential elements of a trust is the trust terms. So the trust terms are typically set out in a trust deed. You also have legislation and common law principles as well. So the trust deed is like the written document governing the trust. There are also rules in the various trusts or trustee legislation in each state. Typically, the trust deed will override what is in that legislation. It can also override what's in the common law, and generally you would have a very comprehensive trustee. That's why our trust needs are 30 pages long because as I mentioned, the trustee role is a fiduciary. They need a positive authorization before they can action in relation to the trust property, every single action they might want to take needs to be specified in the trust deed where you have a bare trust or a fixed trust with very little terms.
(29:56):
And an example of that is, oh, well, I'll just hold this money for my children or a gift under a will to children who are minors. Then you might find that the bulk of the trust terms are set out in the legislation and the trustee, just because there's no trustee, doesn't mean there's not a trust. You still have a trust. The trustee just has a lot more stricter requirements and less flexibility. They can only do what's in the trust legislation. And generally speaking, the powers and flexibility of a trustee in the trust legislation is much, much narrower than what you would see in a trust deed. So the terms of the trust deed are really important. That's why we go on and on and on about how good and comprehensive our testamentary trust terms are. But you don't say that there's no trust just because you don't have a comprehensive deed, you will always have the terms. I want to just take a little break before I make some concluding comments. And I love UL to hear from one of our lovely members, Fiona Henderson.
Fiona (31:13):
Hi, my name's Fiona Henderson. I'm the founder and principal of Argyll Law. We are an estate planning firm amongst other things. We have invested in Tara's precedents and in the testamentary precedents club. We love the precedents because they came coded already with our practise management software. But my favourite part of Tara's offering is her testamentary trust precedents club where she provides in-depth training in testamentary trusts. And we have found that invaluable for our junior staff to get them up to speed with the depths of knowledge about testamentary trusts that would take years for them to get just doing it as they go on the job. So we have really benefited as a firm from the training that she provides in the TT precedents club, and I would highly recommend that you check it out.
Tara (32:09):
Now, in my concluding comments, my objective for this episode was really just to help you feel more confident that you understand at its core how a trust works and what a trust is so that when you are faced with different types of trust, whether it's a unit trust, fixed trust, super fund, limited recourse, borrowing arrangement, trust, a bear trust, protective trust, charitable trust, family trust, inter vivos trust, testamentary trust that at its core that this is an arrangement where we are separating control from the right to benefit that we need to have trust property, a controller beneficiaries, and some trust terms, and it will be in the trust terms and the entitlements of the beneficiaries where we distinguish the type of trust that we are dealing with, like the unit trust, the beneficiaries will be the unit holders, the people who hold the set compartments of the trust akin to a company in a fixed trust, the beneficiary entitlements are certain and fixed.
(33:23):
They'll have a certain percentage or share in the assets of the trust. The trust property. A bare trust will be where we have an arrangement of a trust, but we don't have comprehensive trust. Terms of inter-vivos. Discretionary trust has got a broad range of beneficiaries where the entitlements are at the sole discretion of the trustee. A testamentary trust, same thing. You can have a testamentary discretionary trust, a testamentary fixed trust, a testamentary bear trust. So there you're looking at two things, was this trust established by will on death? And then secondly, what are the entitlements of the beneficiary? It's probably not even actually correct to say established by will. Often a good testamentary statutory trust will be established by will, but even on intestacy, you have a testamentary bear trust. If an entitlement on intestacy goes to a minor, well, they can't take their inheritance until they reach majority.
(34:31):
So we have got a testamentary bear trust established as a result of a death of somebody where we have a beneficiary but not comprehensive terms, and we're referring to the trust or trustee legislation in that state. So don't get overwhelmed. Now you know the core principles and elements. When you're presented with a structure that is a trust, you can just kind of break it down. Is it intervi? Is it testamentary? Who are the beneficiaries? What are their entitlements? And then you'll have an understanding. Really reading the terms of a trust deed where there is a trust deed is essential to understanding the arrangement. We can never make assumptions about a trust deed because they just vary so wildly. You always need to read all of the terms and bring your trust interpretation principles to the deed. But I just wanted to go over these foundation principles because it's not as intimidating or complex as it seems, and you've totally got this.
(35:37):
So thank you so much for tuning in, and I will see you next week.
