Tara (00:50):
Welcome to the Art of Estate Planning Podcast. It's your host, Tara Lucke. I am so thrilled that you've joined me. This is episode 101 of the Art of Estate Planning Podcast, and so I thought it was really fitting to actually do a Testamentary Trust 101 episode.
(01:15):
So believe it or not, we haven't actually gone back to the very, very fundamentals of testamentary trusts in this entire hundred episodes, so there's no better time than the present. I also just want to mention that normally this podcast is designed for professionals in the estate planning space, so lawyers, accountants, financial advisors, and other professionals who serve clients around estate planning. But for this episode, I actually want to speak to everybody. So whether you are a member of the public looking into testamentary trusts, perhaps your professional advisor has sent you this episode as a bit of an overview. Welcome. A lot of the other episodes may not be your cup of tea. They do just assume a base level of knowledge. But in this 101 episode, I really do want to be able to give you the foundations to understand what a testamentary trust is, make a decision about whether it is a solution that you would like to use in your estate plan.
(02:32):
So let's dive into it. I am so passionate about testamentary trusts. I really think they are an estate planning superpower. I think they are life-changing for many Australians, and they really are worth turning your mind to when you are preparing a will. You don't necessarily have to just accept my blanket recommendation to use a testamentary trust. What I want to do out of this episode is to give you enough information so that you feel empowered to decide whether a testamentary trust is going to align with your legacy building objectives and how you want to provide for your loved ones. Now, the reason that I think testamentary trusts are an estate planning superpower is firstly, they provide amazing tax flexibility, particularly income tax. And I'll show you a few examples about that. But really the main benefit is the tax-free income to minors. You cannot get that treatment in any other structure that you can set up while you're alive or after you die.
(03:46):
These are an absolute unicorn in the tax planning space, and tax-free income to minors is what is really life-changing to young families. There's also the ability to accumulate income at marginal tax rates instead of penalty tax rates, which other trusts have to deal with. They sometimes allow you to defer capital gains tax, and probably my favourite benefit is not tax related at all. It's about protecting the legacy for future generations. So testamentary trusts offer incredible asset protection from both relationship breakdowns and also if any of your intended recipients go through bankruptcy. So if they're in a high risk occupation where they could be sued, so maybe they're running a business or they have an occupation where they can be found negligent like engineers, doctors, lawyers, the inheritance is not available to satisfy any claim against them from a creditor. I also just love them because they can protect immature beneficiaries from wasting their inheritance, whether that's just young kids who are not legally able to own property because they're under 18, or even if they're over 18, but they're still very financially immature.
(05:17):
Testamentary trusts allow you to provide for them and set it up in a way that they can always benefit, but they are not actually the ones in charge of managing the money and making the decisions. So they're really good from protecting beneficiaries who aren't ready to manage this large amount of inheritance. We've all heard war stories, I'm sure, where young people come into a lot of money, whether it's a lottery win or an inheritance, and they just blow through it. And it's absolutely tragic because you think if they had actually invested that money or managed it prudently, they'd have a nest egg that would be there for them when it's time to buy a home and really set them up on a whole new trajectory. But because they wasted it on a good time, risky investments, depreciating assets like fast cars, the whole thing, there's really nothing left for them when they need it.
(06:24):
I also really like testamentary trust because they let you plan for multiple generations. So you as a will maker have some comfort that not only are your children going to benefit, but your grandchildren, and ideally your great-grandchildren will also benefit. And we're not exposing the inheritance to influence from bad actors or people breaking up and then entering into new relationships and suddenly the inheritance you've left them is with a new spouse of someone and totally out of your bloodline. I'm going to elaborate a little bit more of those benefits, but those are some of the reasons why a testamentary discretionary trust can really make a difference compared to the basic simple will. Now, I just want to clear something up in terms of terminology. So when you might hear people or even me use the phrase testamentary discretionary trust or testamentary trust, or even you've seen it written as a TDT or a TT, those phrases all mean the same thing, and they are just legal speak for a trust established by your will.
(07:48):
Now, a few things to know, a testamentary trust doesn't start unless you die, so you've got to create it in your will. It has to be in your will when you die. But if you sign your will today with the testamentary trust, you don't have to worry about any administration or compliance. It just sits there in the will. It's dormant. It's ready to go when you die. Also, because most of us don't have a crystal ball and we don't know when we're going to die, you really only get one chance to get this right. It has to be in your will when you die. We cannot reverse engineer those benefits that I mentioned unless it's in your will. So I always say, if you're on the fence, if you're in doubt, put the testamentary trust in your will. It's a lot easier for your executors and loved ones to bypass or choose not to use the testamentary trust than it is to wish that they had used a testamentary trust and there isn't one.
(09:03):
So if in doubt, use the testamentary trust. Can I talk to you a little bit about what trusts are? Some of you listening might be familiar with trust. You might even have a family trust or maybe a self-managed super fund. And others listening may have never really heard anything about trust. And that is completely fine. Trusts can be confusing and there can be some very complicated ways to explain trust. And a lot of lawyers even do trust at uni. They have a lecture on trusts and they still don't really know what they mean. So I want to try my best to just explain it in a very practical way. You don't really need to go back to ye old English and understand the whole history of trust. It's really about understanding how they work in a practical sense for your loved ones. So the key feature of a trust is that we are separating the right to benefit from assets, from the right to control the assets.
(10:12):
So there's a big separation between who's in control of the inheritance and who can benefit. The person who is in control is called the trustee. So they have the legal control of the assets. That means they are usually registered as the legal owner. If you think about a piece of land held on a trust, the registered owner will be the trustee with the land titles registry. The trustee will also have bank accounts in their name, but they actually hold it subject to the responsibilities of the trust. The trustee has the day-to-day management of the trust. They have to administer it for the benefit of the beneficiaries, manage it in their best interests, and they're subject to a lot of responsibilities about being a prudent person and being responsible for those assets. The people who can benefit are called the beneficiaries. So that's kind of easy to remember.
(11:19):
So you cannot actually receive any kind of payment from the trust unless you are a beneficiary. Now, there could be different types of payment, the income or the capital. And just as a little refresher on the difference between income and capital, think of an apple tree. And there's a tree that was planted and each year it produces apples. So the apples that are produced by the tree, that's the income. You can pick those apples, go and eat them, and every year you're going to have new apples. That's the income. The capital is the tree. And if you cut down the tree, then you're not going to have the tree or the income. So who has the right to actually own the tree and take the income? And it might be that some people can get the benefit of the apples, but they can't make any decisions about the tree.
(12:20):
So that's kind of a little trick I like to think of when it comes to the difference between income and capital. Most of the time you'll have the same people who can have the income and the capital. So in a trust that we're talking about today, a testamentary discretionary trust, one of the very key important features is that the entitlement of the beneficiaries is entirely at the discretion of the trustee. So the trustee can pick and choose which of those beneficiaries can receive a benefit. So how much money can they each receive from the trust? Each year, the income can be allocated out to the beneficiaries and the trustee can decide to just keep the capital invested, whether it's in cash, shares, managed funds, property, commercial property. They can invest in nearly any type of asset as long as they do it responsibly. So they can either keep it invested and just generate the income, keep that tree there and produce the fruit, or they can actually release some of that capital.
(13:37):
And that can be done as a loan or as an actual payment and that part of the capital leaves the environment of the trust. So the trustee has the total choice about how they do that for the beneficiaries. The only sort of restriction is that they must give real and genuine consideration to the beneficiaries and their interests and manage it in their best interests. But if you are just sitting there as a beneficiary and you are not a trustee, then really you're at the mercy of the trustee. Now I want to say you can be a trustee and also a beneficiary. So if you are a trustee and also a beneficiary, you may not really notice this separation between control and benefit because it's going to look and feel a lot like your money. You are in control, you decide if you give yourself a benefit or not.
(14:36):
But if you are not in control, then you don't know if you're going to get anything from the trust. So there's ways as lawyers that we can really manage this difference to achieve the objectives that you want for your estate plan. Now there's another role I will mention, another control role. This is usually optional, but I do recommend that you include it. And it is the role of appointor. The appointer is actually the ultimate controller of the trust because they can unilaterally sack the trustee at any time. So they can actually boot out the trustee and put someone else in. Now, if you are the appointor and the trustee, then that role is a little bit redundant. So sometimes you might see it like that, and it's really just set up so that down the track in future generations, we might want to have different people holding those roles.
(15:36):
You might also set it up in your estate plan so that you do have different people holding those roles right away. And the reason you might do that is if you want someone to supervise the trustee. The trustee is the right person for the day-to-day running around, but maybe you want someone with a bit more grey hair or scents or representing interests of some of the beneficiaries to just supervise what the trustee is doing. Del, one of the main things you'll hear me mention is it's really important to work with a lawyer and estate planning specialist lawyer when you are setting up a testamentary trust, and they will be able to guide you on the types of decisions and how you would want to structure your particular testamentary trust based on your needs and the objectives that you have for your loved ones. The other thing I do just want to mention is that a testamentary discretionary trust can run for a really long time.
(16:37):
So in some states, it can run for up to 80 years from the date that you die. In Queensland, that has been extended to 125 years. In South Australia, it's unlimited. So these testamentary discretionary trusts can really be viewed as a long-term wealth accumulation vehicle. To be fair, they are the kind of structures that keep wealthy families wealthy. Historically, a lot of wealthy families have used these because they are the ones who are paying the top lawyers and getting the advice. And what it means is that their inheritances are in an environment where there's a lot of protection from bad actors and outside parties, and they also have a lot more tax flexibility and in many cases are paying a lot less tax. So these days I strongly believe that testamentary trusts are not just for rich people and they're not just for those messy situations.
(17:47):
They are life-changing for everyday families. A lot of the time now with property prices, superannuation, automatic life insurance in your super, a lot of us are worth a lot more debt than we are alive. And when you actually look at what that amount is, it can be sometimes multiple millions of dollars, even if you don't see yourself as being a rich person. And using a testamentary trust for that inheritance can really make your inheritance go so much further and create a legacy that lasts for multiple generations. So here's my rule of thumb about when I think you should consider a testamentary trust. So if you're talking to an estate planning lawyer, I think that you should ask them to explain to you whether a testamentary trust would be helpful if any of these are relevant for you. So if you tick any of these, I think testamentary trust should be on the table as a possible option for your will.
(18:55):
Number one, at least $500,000 of investible assets will go into your estate after you die. So when I say investible assets, what I mean by that is once they've collected in all your assets, paid off any debts, and there's assets that will generate income or are capable of generating income. So if your beneficiary is going to just pay off their mortgage on their house, buy a new car, and take everyone on a big trip to Disneyland, and there's not going to be a lot left over, maybe they don't want a testamentary trust. But if there's going to be a decent pool of assets around, then I think a testamentary trust is absolutely on the table. Now I've said $500,000. There is no rule about that. It's not in any law. That is just assuming there's sort of like a 5% return, then that kind of amount would generate a decent income.
(20:01):
But if you are more worried about protection, then maybe $350,000 is a big sum of money that should be protected when you think about it. The next criteria to think about is if there are minors who can benefit from $22,000 of tax-free income each year, each minor. So if you invest that inheritance and it creates an income and there are minors, then each minor can receive about $22,000 of income tax-free. So if you've got three kids, the first $66,000 of income that is generated from investing your inheritance can be provided to those kids tax-free. So it doesn't have to be children, it can be grandchildren, it can be nieces, nephews, anyone you like. They don't even have to be related to you. So if you have a lot of minors, whether it's your children or people that you love, or your children who have children, so your grandchildren, it's worth thinking about.
(21:13):
And lastly, if it is important to you that the inheritance is protected from your loved ones going through a relationship breakdown, or if they have a bankruptcy risk because of a high risk occupation or they're running a business, then I would recommend you talk to a lawyer about a testamentary trust. Now, I appreciate that this is a lot of information. So I wanted to talk you through a case study to sort of wrap your head around what this means in practise. So I'm going to do two case studies. One is if you are a young couple with young kids, and then I'll also do a case study where if your kids, you have your couple, but your kids are grown up and you've got even grandchildren or anticipating grandchildren. So let's start with the young couple. I want you to meet Dan and Elsa. So they in their mid - 30s, they've got three young kids under 10.
(22:13):
So they might think that when it comes to doing their will, they just want to do a basic will. So if Elsa dies, she leaves everything to Dan. If Dan dies and Elsa's already dead, then they want everything to go to their three kids. Now, obviously, those kids are little, they are all under 10, so they can't manage the inheritance. Someone needs to step up and do that. So they've chosen Elsa's sister, Anna, to be that. So she is actually going to be the trustee. And what will happen is she will run that trust for those three kids. They each are entitled to the set third entitlement of the inheritance, and when they turn 18, they can get their money. So that's probably what you might've had in mind or your experience with estate planning. Let's consider what the estate plan would look like for Dan and Elsa if instead they chose a testamentary discretionary trust will.
(23:14):
So in the scenario, if we pick on Elsa, so Elsa dies, Dan is alive, and the three kids have also survived. So poor Elsa, she passes away. In her will, she set up a testamentary trust. What she would've done or what I would recommend that she perhaps do is make Dan the trustee of the trust, and the beneficiaries would be Dan and her children. And then we would include future children and grandchildren and maybe her extended family as well. But the real intention is that the trust is to be run by Dan, so he's in control, and the people who can benefit are Dan and the three children. So remember these trusts, their main feature is that we're separating control from the right to benefit. Now, if Dan is in control, it's going to look and feel like his money, right? Because he is just going to run that trust for himself and their kids.
(24:22):
And he can choose each year, how he invests the inheritance, whether they pull out some of the money to pay off the mortgage, whether he refinances the mortgage with the trust and so pays out the bank, and then instead has a loan to the trust instead. Whether he keeps paying the mortgage with his salary and goes off and invests the inheritance in managed funds, he's totally up to choosing what he does there. And then also any income that it earns, he is the one who decides whether he gives that money to himself or to the kids. So it's going to look and feel like his money because he's in control. Now, there's three reasons why Dan and Elsa might choose the testamentary discretionary trust over the basic will, and I want to step you through them. The first one is that Elsa is protecting the inheritance for her kids in case Dan re-partners.
(25:30):
The second one is the tax-free income. They've got three kids. They can get around $22,000 of tax-free income each year. So that's incredible. And lastly, they protect the kids from blowing their inheritance if they both die together. So let's go back to that first one, protecting the inheritance from Dan re-partnering. So let's say Elsa dies, and she actually has about a million dollars in life insurance and super. And that goes to Dan and the kids. Now, let's say five years later, that's a suitable mourning period, right? Dan meets his new spouse, Louise, and they get married. What happens if after marrying Louise and having another baby with Louise, Dan dies? Let's look first about what happens to the million dollars from Elsa if Dan and Elsa only did basic wills. So if they didn't use the testamentary trust in their wills. So Elsa dies, the million dollars goes straight to Dan.
(26:39):
It's just in his account in his name. Dan marries Louise. He should make a new will when he marries Louise. Maybe he doesn't. Who knows what he does? Let's say he does go off to make a new will. He's got a really tough problem in front of him because his children with Elsa are now grown up. Let's say they're at university, late teenagers. So Dan's been providing for them and they're sort of on their way to leaving the nest. He's got a new baby and he's got a wife who he needs to maintain. So when he's looking around about what he owns and how he's going to split that up amongst his family, he's got a tough job because Louise and that new baby need a lot more potentially than his kids with Elsa. But he's got a million dollars from Elsa. So how is he going to ring fence that million dollars, which really ought to go to the children of Elsa, right?
(27:39):
So even if he wants to try to ring fence and just segregate that million dollars from Elsa just for Elsa's children, it's highly likely that Dan has put some of that money into the family home that he owns jointly with Louise. And when you own a property jointly, it doesn't go under the will. When it's owned as joint tenants, it goes straight to the surviving spouse by survivorship or the joint owner, which in this case is Louise, the surviving spouse. He might've also put some of that money into Louise's super while she was on maternity leave as a co-contribution. It's very likely that some of that money from Elsa is no longer traceable from Elsa and it's been intermingled with the assets between Dan and his new wife, Louise. Even if that hasn't happened and Dan is still trying to ring fence the million dollars for Elsa's children, Louise and their baby can challenge Dan's will.
(28:43):
If they don't think they've received enough, they can challenge the will and that million dollars is on the table available to satisfy that challenge. So I would say evaluating all of that, it's really hard for me to give Elsa any kind of certainty that if she dies first, her million dollars will end up just with her kids. It's highly likely a lot of it could end up with Louise after Dan dies. And then those kids are sitting there waiting for their stepmom to die. And if she lives till she's 90 and spends it all, if she remarries and then she dies and it all goes to her new spouse, I just don't think Elsa's children are going hand up with that money. But Elsa could use a testamentary trust will instead of the basic will. And if she leaves her million dollars into that testamentary trust, remember Dan's in charge, he's controlling it for the benefit of himself and the kids.
(29:49):
But the critical thing is that when Dan dies, his will does not re-gift that million dollars. The money stays in the trust. The trust keeps on keeping on. Dan obviously can't control it anymore, so Elsa's sister Anna will run it. Dan obviously can't benefit anymore. He's died. The people who can benefit are Elsa's children. So that money is ring fenced. It's in a separate pool and Dan's will does not redistribute it out. So we're not relying on Dan's will. Dan can go and live his best life. He can remarry. He can find love again and have another baby, and we don't care because Elsa knows that that money is protected in the trust for her kids. We are not relying on Dan to do anything. She has already set up the plan for her kids when she made her will. It's also, unless you're in New South Wales, there's a bit of an asterisk there, but in all the other states, even if Dan's will is challenged, the inheritance from Elsa in her testamentary trust is not available to satisfy that challenge.
(31:08):
So Elsa is in a sense ruling from the grave. She has set up that plan for her babies when she made her first will and she is not relying on Dan to do anything about it. So I really like testamentary trust because it just allows you to not worry about what the surviving spouse does when you're in a couple and one of you dies first. They can go and re-partner and live their best life without it affecting the inheritance. It doesn't mean that inheritance can go out of the bloodline when you use a testamentary trust. There's also a much less likely chance that the inheritance from Elsa is going to be intermingled with Dan and Louise because it's in the testamentary trust. So what that usually requires is the testamentary trust has its own bank account. So the money doesn't go just in Dan's personal bank account.
(32:10):
It's in a special bank account for the trust. The trust does need to make a tax return and have its own balance sheet each year. There's usually an accountant involved and it's not an expensive process, but you probably can't use the sort of shopping centre tax return guys to do the tax return for the testamentary trust. It does require accountant. And there's just a level of integrity and separation that would prevent the assets of the testamentary trust just being mixed in and confused with the assets between Dan and Louise. So let's switch gears. What about Elsa dies and she leaves her million dollars in super, but Dan doesn't die this time. He still meets Louise, they get married, and then 10 years later, Dan and Louise get divorced. So if Elsa and Dan had actually just used a basic will with an old testamentary trust, then Dan would've received that million dollars from Elsa, taken that into the relationship with Louise, and that million dollars is just on the table in terms of them dividing up their property and doing their family law property settlement.
(33:29):
There's really nothing Dan can do to say, "Nope, this money is actually for me and our kids that I had with Elsa." It's just on the table. There's a high likelihood that a fair chunk of it will go to Louise, especially if it's been mixed in with their family home ownership or super or intermixing between their personal assets. Compared to that to if Elsa did a testamentary trust will, it is not automatically part of the family law property settlement that gets divided. It is separate. I would never want to say when it comes to family law that anything is bulletproof because it really does depend on the particular facts and the structure and the way the money's being managed. But what it does is it shifts the burden. So with a basic will, the inheritance from Elsa is just mixed in their property. With the testamentary trust will, it's not mixed in.
(34:32):
And Louise has to argue and prove to a court that the inheritance from Elsa should be divided up in their property. So it's a lot harder to attack it. And because I said there's usually bank account separate for the trust, its own financial statements, then there's a lot more integrity around keeping it separate. So it really can make the difference about protecting the inheritance if there's a divorce. The last benefit that I want to drill down into is the $22,000 of tax-free income for minors. So let's think about Elsa dies and Dan and the kids survive. Forget Louise and the new baby. Dan invests the inheritance and it earns $50,000 of income each year. Now with a basic will, if Elsa and Dan made a basic will, then Dan receives that $50,000 in his personal tax return. So imagine doing your tax return, you've got maybe some employment income, you might have some other dividend or something income maybe.
(35:47):
The $50,000 just goes on top of that. So it could actually move you up a tax bracket and you just pay tax on that at the rate, the marginal rate that you have. Then after Dan has paid tax on all his income, including that $50,000, he's got to pay for the kids, pay for their school, pay for running the home, everything. So that's not outrageous. That's kind of how we all live our lives now, right? So that's fine. With the testamentary discretionary trust will, if Elsa used a testamentary discretionary trust, the $50,000 does not have to be taxed with Dan. It can actually be allocated between the children, and they each have a tax-free threshold of about $22,000. At the time of recording, so this is 2026, you sort of get the tax-free threshold plus there is a low income tax offset, which brings it up to $22,000.
(36:46):
So that can change, but that's sort of the broad number. Now there's three kids, so they actually have a full tax-free amount combined of $66,000. There's only $50,000 of income, so all of that is tax-free. So rather than Dan having to pay tax on it and then pay for the kids, he can use that tax-free income to pay for their school, all their uniforms, their books, all the extracurricular, all the sport, the music, the swimming lessons, their share of the household expenses. So this is what I mean about testamentary trust being life-changing for young families because Dan and Elsa both worked. Now they are down to one income. They might still have a mortgage. Because they have access to this tax-free income. Dan doesn't necessarily have to dip into the capital. He doesn't have to actually use the million dollars on their living expenses because that $50,000 is not being reduced to $30,000.
(38:02):
He gets the full $50,000. He's not paying tax on it, and he can use that for the kids. So it just makes the inheritance go that much further. And this is every year. So this is while the kids are 18. If they're at uni and they're not earning very much, they can keep doing it. And at the time of recording, you also get to do it for the next generation. So when Elsa's kids grow up and have children of their own, they get to do the tax-free income for their kids as well. So it just makes that inheritance go so much further. You cannot get this tax outcome in any other way. You can't go and set up a family trust today with your accountant and get that tax amount. In fact, the maximum at the time of recording that you can actually give to those kids is $416.
(39:00):
Anything above that you're paying the maximum tax rate on as a penalty. So the 22,000 tax-free recognises that someone died. We only get this because Elsa died. It's an inheritance. We are not sort of doing this as a tax avoidance strategy. It's just recognising that it's not fair for the government to get a lot of tax from the income of an inheritance, but you only get one chance to get it. It has to be in your will when you die. Now, the third thing we talked about about why a young couple like Dan and Elsa might want to use a testamentary trust is about the scenario if they both die together. So they leave their kids as young orphans. Now with the basic will, there's still a trust. It's just not discretionary. So like I said, with the testamentary discretionary trust, the trustee chooses which of the beneficiaries get a benefit, how much and when.
(40:03):
So if we roll back to that scenario where Dan is the trustee of the testamentary discretionary trust, running it for himself and the kids, if one of those kids has a health condition where they need a lot of medical treatment, there's a lot of expenses for them, then the kids might not all get an equal third. He might give more towards that child who has their special needs. So he has the flexibility to adapt based on how things are. He could decide to give everything to himself. If he's not working, if he's on a low tax rate, that might make sense. So he's got a lot of flexibility. With a basic will where we've got young kids, so if you're under 18, you still need a trust for them, but it's not discretionary. It's what we call fixed. So Dan and Elsa's three kids are each entitled to a fixed third.
(40:59):
There's certainty that they will each get their third of the inheritance. And basically what happens is once they turn 18, even if the will says you can't get it till you're 21 or you're 25, they can actually force that they get their share once they turn 18. As soon as you turn 18, you can demand it. But that rule about demanding your inheritance once you turn 18 does not apply if your inheritance is in a testamentary discretionary trust. So what Dan and Elsa can do is actually leave guidance for their loved ones like Elsa's sister Anna, and let her know when they think the kids will be ready to take it over. So they can nominate and say, "I want the kids to get their inheritance when they turn 25 or 30 or whenever you think based on these characteristics, when you think they're financially mature enough." And the kids can't force it once they turn 18.
(42:04):
So the testamentary trust really lets you put people that you trust in charge of managing it until the age that you want for the kids. Now that doesn't mean the kids don't see ascend. They can receive money for their first car. If people are buying cars in the future, they can receive money for a house deposit, they can get the income, they can get all their expenses paid, but the kids are not the ones in charge of the investments and deciding how much money to release. So I hope that's demonstrated how a testamentary trust can work compared to a basic will for a young couple. Let's talk about it where we've got a couple who are a bit older who have adult children and perhaps grandchildren or expecting grandchildren might arrive someday. So let's meet John and Sue. So they've got three adult children with some grandchildren.
(43:04):
So why would John and Sue use a testamentary trust? They're probably not as worried about the survivor of them going through a relationship breakdown, but if they are, they can do it in the exact same way and get those benefits in the exact same way as Dan and Elsa. But if they're not really worried about that, they might be more worried about their kids going through a relationship breakdown. The divorce is almost one and two. They've got three kids, so statistics sort of indicate that at least one of them might end up going through a divorce. So they don't want to see their inheritance passing to their child and then their child going through a divorce and it going into the hands of their son or daughter-in-law and out of the family bloodline. They also might want to set their children up in this tax environment so that their children can get the $22,000 tax rate income for their children.
(44:13):
So it's not necessarily their adult children who need that, but if their adult children are having young babies and have to pay for private school or all of their living expenses, again, it just makes that inheritance go so much further so that their kids aren't paying as much tax on the inheritance, especially if their kids are working, are already earning salary and wages. If their kids have enrolled their kids in private school, it just means they don't have to dip into the capital. And lastly, it protects the inheritance for the grandchildren. So I'll talk through each of these in a little bit, but let's say John and Sue are actually Dan's parents. So if Dan and Elsa break up after Dan receives the inheritance from John and Sue, the inheritance, if John and Sue gave it to Dan under a basic will, then that money is just part of Dan and Elsa's assets, and it's on the table to be divided up in any way.
(45:20):
And there's a real chance that it could end up passing to Elsa and then Elsa might remarry and it's totally out of the bloodline. Whereas if it's in a testamentary trust will, the inheritance from John and Sue is not part of the property that gets divided between Dan and Elsa in their family law settlement. It is ring-fenced. Dan can build a case, but that money is actually for his kids with Elsa. He is just a custodian of it during their lifetime, and he can try and is really on the front foot to keep it out of any divorce proceedings. Also, let's think about the tax-free income. So again, pretty much the same that we talked about with Elsa passing away. If John and Sue die and they leave Dan an inheritance, it generates $50,000. He's got to pay that $50,000 in his personal tax return.
(46:17):
So he'll pay tax on that, and then they use the money to pay for the kids after tax money. But if it's in a testamentary trust, then rather than Dan paying the tax on the $50,000 that his parents' inheritance generates, he can allocate that the first $66,000 tax-free to his kids. So that just makes their overall family tax bill a lot lower, and he doesn't have to dip into the capital. Let's talk about what happens if Dan's parents, John and Sue, die, and then Dan dies. So Dan got the inheritance. Let's say John and Sue didn't use a testamentary trust will, they just used a basic will. Dan bought the inheritance and then he dies. And Dan also made a basic will. So under his will, it leaves everything to Elsa. That's pretty common, right? Spouses leave everything to each other and then to their kids.
(47:17):
So Elsa now has the inheritance from John and Sue. Elsa then re-partners. She remarries, has a new baby, and makes a new will. And under her new will, she leaves everything to her new husband. So when Elsa dies, suddenly John and Sue's inheritance ends up with Elsa's second husband and maybe any kids that they had together. And Dan's kids, John and Sue's grandchildren are relying on Elsa's second husband to die, to not remarry, to not have more children. And there is just no comfort for John and Sue that their grandchildren, Dan's kids, will end up with their inheritance. But if they'd use the testamentary trust will, they do get comfort because when Dan dies, it doesn't go to Elsa. It stays in the testamentary trust. Elsa is not part of that testamentary trust. She's not a beneficiary. She's not a controller. Someone else, maybe John and Sue's other children are the trustees, and they run that trust for Dan's kids.
(48:31):
So they have a lot more comfort that it stays in the bloodline. So what I like to say is a bit of an analogy around the difference between a basic will and a testamentary trust will, and it really focuses on the protection. So it's a bit like camping. If you like camping, hopefully this resonates. So you go camping, you're pretty basic, you're camping in a tent. Now you've got the original tent and then the waterproof fly. Doing just a basic will is like going camping and not putting on the waterproof fly. The testamentary trust is the waterproof fly. So if you don't put that on and you just go with a basic will, you've technically got a roof over your head, right? You're asleep, you've got the roof over your head, but if it rains, if there is bad stormy weather, you have no protection.
(49:29):
When things go wrong, you are actually not protected because you didn't go to that next step and put the waterproof fly on. And it's the same with estate planning. The testamentary trust is like the waterproof fly on your tent. So just to recap, a basic will does not give you protection for the inheritance on bankruptcy or divorce. It does not give you tax-free income for minors. It does not let you choose amongst your loved ones about to maximise their marginal tax rates. It does not protect financially immature beneficiaries from blowing through their inheritance. I will give you this. It is simple and easy to understand, and it's probably something that you're already pretty familiar with, but that's really the only thing going for it. Whereas the testamentary trust will protects your inheritance from bankruptcy and divorce. I don't want to say on a divorce that it's bulletproof, but it certainly gives you much better protection and it gives you a fighting chance.
(50:30):
It allows tax-free income for all minors an environment that you cannot replicate or get in any other way. This is because they're recognising that somebody died. It protects financially immature beneficiaries from turning 18 and wasting their inheritance. And it is a little bit more complex. Your will is a little bit longer, but hopefully you can tell from this episode today that it's not that hard to manage. And from a practical perspective, it is easy to run and operate. You might need a little bit of guidance from your accountant and the lawyer to get it up and running, but once you wrap your head around it, it's really not that complex. Now, I don't prepare testamentary trust wills for the general public. I am a lawyer, but I support other lawyers. So please don't ask me to prepare your will because I will have to send you away.
(51:32):
What I recommend you do when choosing your estate planning lawyer, if you have a few to check out, or if you are doing your own research, is assess them on these four criteria. These four things is how you can tell if your estate planning lawyer is legitimate. So one, they don't just offer to do a will for you. They also offer to do your enduring powers of attorney for medical and financial matters, because a will only applies when you die, and a comprehensive estate plan also needs to cover a scenario that you're still alive, but you can't make decisions for yourself. A will is only one small piece of the puzzle. So if they only offer to do a will like an online will provider, then they're not a quality estate planning provider. Secondly, they also need to help you with advice about your superannuation.
(52:28):
A lot of us have most of our wealth in superannuation and our life insurance in superannuation, and that is not automatically dealt with by your will. It's not a default outcome. You may need extra nominations, so you need a lawyer who's going to review that for you and tell you what to do. They also need to be able to talk to you about testamentary trusts. And even after listening to what we've gone through today, you decide or you don't know if a testamentary trust is right for you, they should be able to at least have a conversation with you and give you the reasons why a testamentary trust might work or the reasons why it's not necessary. So if they completely dismiss it or say, "We don't do testamentary trusts," or, "You don't need to think about it," I would really just push them and say, "Well, explain to me why." And if they can't do that, then I don't think that they are experienced enough to help you.
(53:29):
And lastly, you need to be able to meet with your estate planning lawyer. Now, that could be an online meeting or in person, but they need to be able to actually consider your particular circumstances, talk to you about your family, the dynamic, what assets you have, and make sure that they have customised the plan to achieve your goals. If they are just whipping out an off-the-shelf solution without considering your unique family and assets, then it is not a quality solution. And so they need to be able to at least talk to you to be able to ask you questions and make sure that the assumptions they've made when they prepared the document is right. Now, you might have a lot of questions. This has been quite a long episode and we've sort of just scratched the surface. I don't want to go into all the different variations and ways that you can customise your testamentary trust, but please rest assured that they are highly customizable.
(54:34):
So your estate planning lawyer should be able to give you recommendations and help you make a decision about these types of decisions. So how many testamentary trusts you use? Do you set up a testamentary trust for all of your children to share, like the assumption we made for Dan and Elsa? Or do you set up a testamentary trust for each of the children? So when we were talking about John and Sue, I didn't say it expressly, but they probably would actually, if they've got three kids, each of those kids gets their own testamentary trust. So Dan is not sharing his testamentary trust. With his siblings, he's just got one for himself and his kids that he had with Elsa. Another decision, if you are in a couple, you have to decide, are you going to set up the trust for the survivor of you like when Elsa set it up for Dan and the kids?
(55:35):
Or in John and Sue's scenario, they might wait until they have both died and only set up the testamentary trust for their kids. They don't need it for each other. They want to keep it simple if one of them dies and give everything straight to each other and then only use testamentary trust if they both died. Your lawyer should also be able to talk to you about which assets should pass into the testamentary trust. Sometimes you don't want every single asset in the trust. You may not in fact want your family home into the testamentary trust or at least until you've both died because you want to make sure you get the main residence capital gains tax and land tax exemptions. You will also need to talk to your lawyer about exactly who should control the testamentary trust. Also talk about who should benefit from the testamentary trust.
(56:31):
Do we want spouses to be in there or not? If you have blended families or stepchildren, who's included, who's not? And then also talking about that scenario for Dan and Elsa, and they both passed away, your lawyer should be able to help you customise the plan for when you pass the control of the trust to those kids once they become adults. So testamentary trusts are highly customizable. We've really just talked about sort of general principles today. I hope this has given you enough information to have a broad understanding of what they are, how they work, and why you might consider using one for your estate plan. Thanks so much for tuning in.
