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Protecting family wealth with testamentary trusts

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Testamentary trusts are a popular mechanism for protecting family wealth. They are flexible tools that allow trustees to manage assets for the beneficiaries of an estate. So let’s find out how they work and why they are useful.

As Matthew Brown, a senior wealth specialist with yourcorner.com.au explains, a testamentary trust can be established as part of a will, where estate assets are owned and controlled by the trustee, rather than the beneficiaries.

“They provide flexibility to trustees so they can distribute capital or income to beneficiaries as they deem appropriate. Alternatively they can be a fixed trust, providing beneficiaries with a fixed entitlement to income and capital, or a combination of both,” says Brown.

A trust can also control the age at which individuals can inherit income or capital, which is sometimes useful where there is a substantial inheritance.

To explain how testamentary trusts work, Brown uses a case study of a husband and wife with two children, a son and a daughter. Let’s say the husband unfortunately passes away at 45 with $1 million in super, earning a return of five per cent per annum, a before-tax income of $50,000 a year.

If the money goes straight to the wife, she would be taxed at her marginal tax rate. But if capital is held within a testamentary trust, the family could end up paying no income tax as every beneficiary (the wife, son and daughter) can receive $18,200 tax-free each year.

According to Michael Miller, financial adviser, MLC Advice Canberra, aside from taxation benefits, there are a number of other ways testamentary trusts can help protect family wealth.

One benefit relates to any commercial legal proceedings beneficiaries may face. Miller says when a trust’s beneficiary such as a child runs a business he or she will usually provide personal guarantees over a residential property to help finance the business.

“If anything goes wrong, these and any assets in the child’s own name may be taken to repay creditors. But assets that belong to the trust may be preserved,” he explains.

The final advantage comes to the fore in the event of a family breakdown, says Miller. A testamentary trust can offer some protection in ensuring assets are used for the benefit of direct descendants such as children and grandchildren, should there be a divorce or separation in the family.

“The trust doesn’t make the assets disappear, but it can ensure assets held in the structure remain used for the long-term benefit of family.”