This article was originally published in the Australian Shareholders Association Equity Magazine, December 2013 (Vol 27, #11)
You've thought about it ... but done nothing
Is your personal estate plan on your to-do list but it never quite reaches the top?
It may not be pleasant to think about your death, and even less so to think about the death of your loved ones. Is this why you haven't done anything?
But what if you survive your partner or loved ones? Ask yourself: what has your partner done or not done to prepare and to put you in a position of security and confidence? Your procrastination is one thing, but another's may affect you personally.
Research puts the number of people who die without a Will as high as 60% and of those who believe they have one, many don't know where it is.
Did you know that we lawyers make money out of unplanned or ill-thought of estate planning through lost paperwork, increased complexity and estate claims? Personal estate planning is the final goal setting, and what others do or do not do will impact on you ... and you on them!
The guidance provided in this article should assist you to start thinking about the decisions you will need to make to develop your personal estate plan. The article pays particular attention to why you may wish to consider a tax effective and asset protective testamentary trust as part of your estate plan.
Where to start?
You might be thinking, "I'll be dead! Why do I care where it goes?"
Let me ask you this: do you care whether your children are looked after in the best way possible? What about your spouse? And do you mind whether, after you're gone, your spouse leaves the bulk of your wealth to the pool boy or Swedish nanny (who has kindly consoled them through their grief) ahead of your children? And what about the "charming" boyfriend your little princess has married; can he have some of your wealth too?
Without being too dramatic, estate planning is about asset protection. It involves putting your wealth in the hands of others that you choose, protected from others they may deal with. It's also about you inheriting from another in a manner that protects this in your hands.
Efficient tax planning is yet another very good reason to embark on the personal estate planning journey, setting things up to minimise the taxes that will be paid.
To get you started in developing your personal estate plan, I recommend that you start with an open mind and:
- a pen;
- a blank piece of paper; and
- a fine bottle of wine.
Keep in mind you're thinking about where the assets for which you have worked so hard will end up. Why not make sure it goes to whom you want it to? We're talking about your legacy after all – so be selfish!
Perhaps it's better to start with: what has my partner done? Write down what you want them to have done.
If you don't have a valid Will, the law will decide who receives your assets and how much they get. The laws of intestacy might not benefit the person or persons you want to benefit from your estate.
If you do have a Will, you should review whether it covers all possible situations which may exist at the date of your death, covers all of your assets and benefits the person or persons you wish to benefit from your estate.
You may need to update your Will if:
- the Will is more than three years old;
- your personal circumstances have changed (marriage, de facto relationship, divorce, separation);
- you have had children or further children; and/or
- your financial circumstances have changed.
A review doesn't mean seeing a lawyer; it just means that you need to take it out of the drawer, read it and decide whether you're still happy with it.
Will Check List
- Who should act as executor/default executor?
- Do you wish to make any specific gifts (for example a sum of money, shares in a business, items of jewellery and the like)?
- Who do you wish to act as guardian of your minor children (if any) provided that your spouse (if any) has predeceased you?
- Who do you wish to benefit from your residuary estate if:
- you are survived by your spouse and all of your children?
- your spouse has predeceased you and all of your children are alive?
- any of your children have predeceased you and your spouse is alive?
- any of your children and your spouse has predeceased you?
- all of your spouse and children have predeceased you and you are not survived by any further lineal descendants?
- Do you wish to establish a testamentary trust? If so:
- Who should be the controller of the trust?
- Which directions do you wish to make to the trustees? You may direct the trustees to:
- distribute a certain amount to each of your children e.g. upon attaining the age of 21, their first marriage or completion of their tertiary education;
- invest the trust fund in a particular manner; and/or
- allow your children to borrow funds from the testamentary trust;
- Who will be the beneficiaries of the trust?
- What controls do you wish to impose in terms of when and how the beneficiaries of the trust can access the income and capital of the trust?
- Any wishes regarding your funeral (buried/cremated/donation of organs)
Mary dies leaving her husband Jim and four children under the age of 18. A simple Will giving all to Jim results in a maximum tax free threshold for the children of $1,664 and Jim would need professional help to achieve this.
If instead Mary dies leaving her wealth (life insurance or superannuation) via a testamentary trust the available tax free threshold for the children becomes $72,800. In addition, the family will not pay tax at the highest rate until their aggregate taxable income exceeds $900,000 (that is, for all five family members).
Put simply, the use of the testamentary trust results in more after-tax income for the family.
Should I have a Testamentary Trust?
You've heard the phrase "Last Will and Testament" - a Testamentary Trust is simply a trust established under your Will that doesn't come into existence until after your death. The terms and conditions of the Trust are contained within the provisions of your Will.
Why consider a Testamentary Trust?
Any person who wishes directly or indirectly to benefit children or grandchildren under 18 years of age should strongly consider establishing a testamentary trust under their Will.
Ordinary trusts that benefit children under the age of 18 are subject to penalty rates of tax. The tax free threshold is only $416 and any amount in excess of $416 is taxed at penalty rates which can be as high as 66%.
These penalty provisions don't apply to trusts established under a person's Will (ie. a testamentary trust). From a tax perspective, children under the age of 18 are treated as adults in respect of a testamentary trust. They're entitled to the full tax free threshold, currently $18,200, and the ordinary marginal rates of tax on distributions of taxable income above that.
A testamentary trust is appropriate where the person who it is intended to benefit has children under the age of 18. This is why it can be appropriate for grandchildren, brothers, sisters, aunts, uncles, nephews, nieces, cousins or long term friends whose extended families include members under 18 years of age.
The testamentary trust is also an extremely beneficial tool for parents or grandparents wishing to establish "education trusts" for children or grandchildren. Less tax means more for education.
Under the terms of a properly drafted testamentary trust, the trustee can have discretion to distribute different classes of income (e.g. franked dividends, unfranked dividends, interest income, taxable capital gains, non-taxable capital gains) to different beneficiaries to ensure maximum tax-effectiveness of income distributions.
An example of this benefit is where a trustee allocates the net capital gain component of the trust's net income to beneficiaries with realised capital losses since it is these beneficiaries who can then use the capital losses to offset their capital gains.
Discretionary streaming of trust distributions can also be useful, for example, to distribute unfranked dividends and franked dividends to different beneficiaries.
Asset protection from creditors
This is a key benefit of testamentary trusts.
The testamentary trust can be drafted to give beneficiaries the benefit of a discretionary entitlement to income from trust assets, but no fixed entitlement to trust assets or income. As such, if a legal claim was made against estate beneficiaries, assets held in a testamentary trust would be protected.
Testamentary trusts can provide invaluable protection to a beneficiary of assets of a deceased estate in circumstances where that beneficiary is likely to be subject to claims by business creditors or plaintiffs in legal actions.
Family law protection
One in three first marriages, and one in two other marriages, end in divorce. These statistics can not only be alarming, but also support our experience that a significant objective of estate planning for many is to protect families from concerns that assets left to a spouse, or to children, may be at risk in circumstances of divorce, subsequent marriage or breakdown in a de facto relationship.
In such circumstances, the testamentary trust can be specifically tailored to ensure that a testator's assets stay within their family or direct lineal descendants for a period commonly up to 80 years following death.
The level of family law protection can be tailored to meet the specific circumstances of each client.
Income protection and social security
Leaving valuable assets of an estate to a beneficiary in receipt of social security benefits can immediately push that person over social security thresholds. A testamentary trust can be drafted to secure continuity of social security benefits for such beneficiaries by ensuring they have no entitlement to the assets of the trust.
A complete package
Your personal estate plan is not just about your Will. You also need to consider who you would trust to make decisions for you if you are no longer able due to mental incapacity.
Appointment of Enduring Power of Attorney and Appointment of Enduring Guardian documents can ensure that the people making financial and personal/medical decisions for you are those you trust to decide in the same manner you would if you were able. You can also provide directions to your enduring guardians as to whether to leave life support machines on or turn them off.
What this article hasn't covered is the assets that don't automatically form part of your estate. In a future article we'll discuss how to ensure that the other structures in which you hold your assets, for example family trusts and superannuation, are also appropriately dealt with.
Preparing your personal estate plan is not a question of whether or not you should have a Will – you should – it is about what your Will should contain. Particularly, consider whether a testamentary trust is right for you and your family.
Stop putting off preparing your personal estate plan and start thinking about how you want to leave your loved ones after you're gone. It's not morbid to think about, it's incredibly sensible and important.
Get it done.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.