Tara (00:48):
Thank you so much for tuning into the Art of Estate Planning podcast. It is episode 61. I am your host, Tara Lucke, and today I want to talk about when we should establish a testamentary trust for a surviving spouse.
(01:08):
So we're talking about testators in a couple, and when we are using a testamentary trust, do we set up the testamentary trusts to benefit our surviving spouse or do we wait until both members of our couple have passed away and then set up the testamentary trusts typically for the children? I actually got this question in an email the other day. It was from a financial advisor, but I think financial advisors, accountants, lawyers, we all sort of struggle with this strategy decision and I wanted to share my 2 cents. Now, full disclosure, we deep dive into this in my online course, testamentary trusts the Essential Guide for Australian Lawyers. So I'm going to keep it kind of light and high level because if you really want to dive into the full nuance and complexity, then the online course is the place to go. But I'll tell you about my opinion and how I approach structuring this and also teaching lawyers about this.
(02:19):
So firstly, I am not a fan of a one size fits all strategy when it comes to estate planning and testamentary trust. I really think it's essential for the lawyer drafting the will and devising the strategy to guide the client and give them customised recommendations based on the test. Data's life stage beneficiary needs, their asset protection objectives, the level of sophistication, the relationship between the beneficiaries rather than a here's how we do testamentary trust. And off you go. I also really think it's important to give clients the options, present them through the different ways they could approach this and empower them with knowledge to make the decision themselves. So in any estate planning meeting involving testamentary trusts, there's usually two key decisions. How many testamentary trusts? So we lumping all beneficiaries in a single trust or are we setting up different testamentary trusts, earmarked for singular beneficiaries, so multiple testamentary trusts.
(03:28):
And then when it comes to working for a couple, when do we start the testamentary trust? So is it after they've both died or do we actually set it up to benefit the surviving spouse? So if you are in my course, you will have our decision trees. Those decision trees are also in our estate planning cheat sheets available for purchase on the shop on our website, but we have a little cheat sheet with some very simple, if you tick suit too many boxes in this column, then that's probably the way you should go If you're ticking the boxes in the other column, go that way. So in terms of my very simple decision tree when acting for a couple, I would suggest that the testamentary trust should commence on the first death of the members of the couple to benefit the surviving spouse where there are minor children or grandchildren in the beneficiary classes who can benefit from tax-free income streaming where we actually have enough assets passing through the estate to go into the testamentary trust so they're not held as joint tenants or through family trusts or super or revisionary pensions that are going to go directly from the super fund to the beneficiaries.
(04:49):
I think if we're setting up a single testamentary trust, that can also be in favour and make it simple for the trust to benefit the surviving spouse and where asset protection is important for the surviving spouse potentially. If you also want to rule from the grave, that can also be another factor when we might delay setting up the testamentary trust until both spouses have died would be if you have adult children and there's no grandchildren yet or likely to be on the scene, so no miners for the tax-free income streaming. Secondly, if we have a lot of assets that are held as joint tenants through super or visionary pensions or family trusts and there's simply not going to be many assets passing through the estate, they're sort of going to pass through survivorship or non-state structures in the first instance, then potentially there's no benefit in setting up the testamentary trust for the surviving spouse.
(05:52):
If you really want to plan where we are setting up multiple testamentary trusts where there's one trust earmarked for each child, then you may wish to defer setting up the testamentary trust right away and if they're not really worried about asset protection for the surviving spouse. So the other kind of rule of thumb to make it even simpler is generally speaking, not always, but generally speaking, where you've got young couple with minor children then set up the testamentary trust for the surviving spouse where you've got baby boomer clients with adult children and a lot of money held if they've got super in their home held as joint tenants delay setting it up until they've both died. So let's dive into some of this rationale. So setting up a testamentary trust for the first spouse where they have, they're pretty young, they might be thirties or forties and they've got minor children.
(06:59):
Firstly, I like a single testamentary trust under each will. In that instance for a couple of reasons, and I've talked about this, this is exactly what I've done under my will because I fall into that client demographic, so I don't want to impose on my husband or if we both pass away like our executors, the burden of running multiple trusts and trying to keep them equalised and balanced, it adds a lot of complexity and bureaucracy and we've got a really long time before our children who are currently five and two could take over the trust. We're potentially looking at 20 to 25 years if I had died yesterday where someone has got to try to keep these two trusts running and relatively equal, they're earmarked. So in that my scenario, I think a surviving spouse, my husband can get a single testamentary trust that he runs for himself and the kids, they get all of the tax-free income.
(08:11):
So I keep going on about this, but testamentary trusts are just so important for young couples who've lost a breadwinner instead of the inheritance generating income and that income being taxed in the surviving spouse's name, especially if they're already earning other income. So it will be taxed at a pretty high rate on top of their marginal rate and maybe boosting them up a marginal rate. They can stream tax-free amounts to the kids, so each child can receive about $22,000 of tax-free income each year. So the first 44,000 in my family's case can be distributed tax free to our children and then the standard marginal tax rates just kick in from there. So that's 22,000 is tax free, but then they're just like a low income earner and they have a very low tax rate. So if my husband who is a doctor, a specialist physiotherapist in his area, he's a high income earner, right?
(09:20):
So he's already got a high tax bracket. The kids can instead pay lower tax on the benefit of the income that the inheritance is generating. And let's face it, they are so expensive that most of that income will probably be going towards paying for them anyway. So if you want to dive into how those rules work, episode 45 dives into tax free income for minus. So I go on about I take a testamentary trust will to baby showers and when my friends get married, and I honestly just think it is so, so important for young families who have got a decent amount of life insurance or wealth accumulated to access these structures because it's so life-changing. It honestly can be in what is a terrible devastating event for the family. It can change the financial future for a young family by having to pay so much less tax than anyone else.
(10:26):
So comparing that to a basic will, I just think some cases we can do a post death trust, but the amounts that you can put in the post death trust are limited. You can't even do that strategy in states where the intestacy rules distribute everything to the surviving spouse like New South Wales and Victoria. It's not even an option. And even when you can do it in places like Queensland and Western Australia, it's severely limited. So the testamentary trust, you just get one chance to be able to offer it to a surviving spouse for that tax-free income. I will also just mention my preference in the way that the art of estate planning will precedents are structured is that the testamentary trusts are optional so we can actually bypass the testamentary trust if it turns out not to be needed at that time. So I really dive into that in episode 51 if you want to listen about the mechanisms of that.
(11:27):
But given we have that ability in the precedents, I'm leaning more and more towards the power of setting up the trust just in case. And if it turns out that the way our assets are structured means when my husband sits down with our accountant and financial advisor and looks at everything after I've died, they go, oh, there's really not actually going to be the advantages of the t symmetry trust that Tara was expecting. We can bypass it and you can receive what you need in your own name if that's suitable and we don't need the burden of an extra trust when there's no advantage of it. So I'm sort of leaning on the area of caution because one, you basically cannot re-engineer a testamentary trust if it isn't in the will and instructed to be established at a particular time. So there's no going back and no second chances you only get one shot.
(12:28):
And then secondly, when not locking it in stone, so if they do get advice and decide to bypass it, they can. So why wouldn't we put the trust in there for them? Now if you are thinking, what about ruling from the grave and your husband repartnering and undermining the trust, that is absolutely a legitimate concern for some people it's not a concern for me. I know my husband will get advice and do the right thing, so I trust him and I'm more worried about external creditors and maximising the tax advantages rather than limiting his power. But if you do want to look into that, we actually did a deep dive into that concept and some of the strategies you can utilise to minimise that risk or give people peace of mind about what their surviving spouse can do in episode 12. So right back to the beginning, go back and have another listen to that episode.
(13:28):
Another advantage of setting up a testamentary trust to benefit a surviving spouse is asset protection. So particularly when it comes to the surviving spouse and also bankruptcy exposure. So as I said, my husband does run businesses, he's a doctor, so we're concerned about bankruptcy exposure and claims through his occupation, but also there's a chance he will if I were to die. Now when it comes to family law, I mean I probably should do a big deep dive episode on this, so I'll just sort of touch on it briefly. We do deep dive into this in the course, the Essential Guide for Australian Lawyers. So if you want to dive into that further, the course is the place to go. But briefly speaking, even though we can't say there's absolute protection from relationship breakdowns under family law, property settlements from the assets in the testament trust, it really sets the inheritance up for protection and success by being in a testamentary trust for a couple of reasons.
(14:37):
First, it shifts the onus of proof. So rather than the inheritance that I've left to my husband for him and the kids being automatically in the relationship pool as his property, it's actually outside of the relationship pool and his new spouse on a relationship breakdown has to bear the burden of arguing that it is relationship property. So it switches the onus of proof from it automatically being in and my husband on the back foot trying to argue it's not included to his new spouse having to try and drag it in. Secondly, it prevents or mitigates intermingling because of the integrity of the structure of requiring bank accounts, financial statements, record keeping with the accountant about where the assets are going in order to get those tax advantages. It's much less likely that the capital is just going to be mixed up into a new family home or property that him and his new spouse own and it's hard to trace what's happened.
(15:44):
So there's a lot less intermingling and a much clearer trail of where funds are going and if he still wants to use some of the inheritance to help with a family home, that can be done as a secured loan. So the equity returns to the testamentary trust on a relationship breakdown. For instance. The other thing I really like about the pre testamentary trust for the surviving spouse is if when he dies my inheritance is already in the testamentary trust, his will is irrelevant. It's got nothing to do with the inheritance. In my testamentary trust, I've already set up the succession plan in terms of nominating the backup controllers and who will benefit. So he might be a controller of that testamentary trust when he dies, he's obviously stops being a controller and a beneficiary. The backup controllers step in and they keep running the trust for my kids.
(16:41):
So I am not worried about whether he makes a new will, whether he just neglects to make a will and does nothing. I don't care. He can go and live his best life and sort out of his life's admin or not with his new vows. But I've already set up the plan for the testamentary trust. So I really like that there are some downsides and it depends on not all of these downsides will be present in every case, but since the integrity provisions came in about accepted trust income historically that you used to be able to sort of merge or combine testamentary trust for spouses. So if I'm setting up a single trust in my will and my husband's setting up a single trust in his will when I die first, then my assets go into my testamentary trust on his subsequent death. Instead of seconding up an additional testamentary trust under his will, his executor could actually distribute his assets from his estate into the testamentary trust on mirror image terms.
(17:48):
That was already up when I died. So at the end of the day, both our kids just have a single testamentary trust. Now you cannot do that anymore. We would both, well you can, but you won't get the tax-free income treatment for minors under the accepted trust income integrity rules. So I need my assets to go into a testamentary trust set up under my will when my husband dies, his assets go into a separate additional testamentary trust set up under his will, so that could be good. We've got two sons. If the balances are reasonably equal, maybe they just take one trust each or else they jointly manage both trusts together. They've got flexibility there. It can get a bit harder when you've got four kids and they're all sharing or you want to set up assets that where each test testamentary trust is earmarked for one of them.
(18:45):
So there can be a disadvantage at times of assets being stuck in a single shared trust. So when I die, my assets don't come out of that trust. As I just said, they stay in there. And so if you've got your second level of beneficiaries not wanting to share a trust, that can be one of the main disadvantages of setting up the trust in the first instance. So you sort of have to run the gauntlet of how important is the income tax flexibility and asset protection, and how long are we anticipating that the surviving spouse will benefit from this trust. If there's a short amount of time between both spouses dying, the second spouse is dying of a broken heart or something so tragic, then you might feel frustrated that the assets from the first spouse are stuck in that first trust. Again, depending on the timing, maybe if the estate isn't administered, they can do a bypass, but if it's like a three year time difference where the trust is set up, the estate administration is finalised, the assets are owned by the trustee and then the surviving spouse subsequently dies, you could feel like those assets are trapped in there.
(20:07):
In my situation, there's a high chance that if I die young and my husband lives till he's 80 or 90, that he's going to be running that trust for 40 or 50 years, and its purpose has totally transformed from being my testamentary trust through to just another one of our intergenerational wealth family trusts. So there can be some issues there and also flow on factors that we won't go into, but we do cover more in the course. So the main disadvantage is the second line of beneficiaries having to share it. Let's talk about the multiple testamentary trust kind of scenario. So we do have a hybrid solution in our out of estate planning precedents where we set up a testamentary trust, a single testamentary trust when the first spouse dies, and then when the second spouse dies, their will actually sets up multiple trusts. So a trust per child.
(21:16):
So that's another option as well, and it's possibly useful where you've got older couple, well, it can be useful in different scenarios. It could be where if I wanted to know for certain that when my husband dies, we are setting up a separate trust for each of our sons. So at the end of the day they would have a shared trust with my assets. I died first and then their own trust earmarked for them with half of the assets my husband owned. So that can be kind of like a middle ground and I don't mind that sometimes because you might be aware the family law asset protection diminishes when we are setting up a trust for each child where they're earmarked because it looks and feels a lot like their assets and can easily be argued to be their alter ego. So we're sort of taking a bet each way and having some assets that are shared and probably have greater asset protection from family law, but then they also have autonomy over some of their own assets as well.
(22:26):
It can also be a good option for our baby boomer clients where they actually do have a lot of wealth that is going to pass through the estate. So a lot of baby boomers do just have super where they have a reversionary pension and assets held in joint bank accounts and as joint tenants, in which case, let's keep it super simple and not worry about burdening our elderly surviving spouse who doesn't really have a lot of experience with trust. They don't need to learn trust. It's too complex. We don't have the level of sophistication for them, and the adult children can get up to speed with the trust and are going to benefit from it. But let's just keep it simple stupid for that elderly surviving spouse. But where you do have that baby boomer generation where they are sophisticated, they are worried about the surviving spouse repartnering or elder abuse, and they kind of want to rule from the grave a bit or they've got a lot of grandchildren who they're helping out financially.
(23:35):
Then this sort of hybrid strategy of providing the trust for the surviving spouse and then setting up multiple trusts for each children when they ultimately die can be a really good sort of middle ground and option as well. So that's some food for thought. I guess my main message is don't overlook the power of setting up a testamentary trust for a surviving spouse. We only get one opportunity to do it. It has to be in the will before the test data dies. We also typically have the ability to bypass the testamentary trust if it's decided that it's not needed at the time. So I always err on the caution of that's set up the testamentary trust for the surviving spouse, unless it's a really clear cut case of we don't need that complexity. The surviving spouse just doesn't really have the sophistication to deal with it.
(24:35):
There's not a lot of miners around to benefit from the tax-free income. They're not worried about asset protection from bankruptcy and they're kind of happy to take or run the risk from the surviving spouse repartnering, in which case I would keep it simple and not benefit the surviving spouse with a testamentary trust and just give them a basic will. Well, it wouldn't be a basic will, it would still be a testamentary trust drafted will, but the assets would go directly to the surviving spouse, similar to what you would see in a basic will, and then the testamentary trust would be set up in the will, but only starting after both clients have died. I hope that makes a little bit of sense and gives you sort of a taste of the kinds of things that we go through in the essential guide course. Now I'm just sort of talking at you in the course because there are a lot of moving parts.
(25:30):
We've got decision trees, we've got checklists, we've got diagrams showing the flow of assets, comparing the advantages and disadvantages and the different structures. So it is a much more comprehensive explanation. We even show you the clauses. So as before I just said, oh, your will would look a bit like this. I actually show you exactly how to draught that with the clauses in the course as well. So if this has got your interest piqued, but you want to know more, go and check out our online course, the Essential Guide for Australian Lawyers. Thank you so much for tuning in and I will see you next week.
