Why a Traditional Will May Not Be Enough
Contents
1. Estate Planning for Everyone
2. Key Legal Terms
3. Income Streaming
4. Homes and Investment Properties
5. Asset Protection
6. Centrelink Entitlements
7. Flexibility for Beneficiaries
8. Inclusions and Exclusions
Important Notice:
The information in this document is intended as a guide only and may not be comprehensive. It is not meant as professional legal or financial advice and should not be relied upon. Before acting on the information in this guide, seek professional counsel.
1. Estate Planning for Everyone
Estate planning is not limited to wealthy people. To look after your family and protect your legacy, it is important to safeguard your assets and intentions with a smart will. Whether you control a large portfolio or own a single property, a short and simplistic will often does more harm than good.
To reduce unnecessary taxes and secure your estate from creditors and predators, you need a more sophisticated will. With help from this guide, you can upgrade to an astute will and protect the interests of your beneficiaries.
2. Key Legal Terms
Before moving forward, it is important to understand the meaning of key legal terms.
Trust
A trust is an obligation imposed on a person or entity to hold property for the benefit of beneficiaries. This legal arrangement is very common and a powerful way to separate legal ownership from beneficial use. While the trustee has official legal title to the asset, all income earned is passed to the beneficiaries.
Discretionary Trust
A discretionary trust is a special type of trust where the beneficiaries do not have a fixed entitlement or interest in funds from the trust. Under this arrangement, the trustee decides if a particular person benefits from the trust. A "family trust" is one common example of a discretionary trust.
Testamentary Discretionary Trust
A testamentary discretionary trust is set up within a will as a special type of discretionary trust. This trust comes into play when the testator or will-maker has passed away. The discretionary nature of this trust means the trustee has control over how assets and income are distributed among beneficiaries.
Streaming
In a legal context, streaming is passing income from trust assets through the beneficiaries via the trustee. Streaming trust income ensures the tax-effective allocation of income. Streaming is particularly useful for trusts with low-income beneficiaries, who may be in a lower tax bracket.
3. Income Streaming
Income streaming is a powerful legal process that provides financial benefits to the beneficiaries of a will. In a typical scenario, the testator's home becomes the beneficiary's investment property upon death. This generates taxable rental income for the beneficiary, which can be streamed to low-income relatives to save thousands of dollars in tax, year after year.
This process works due to different taxation rates between adults and minors. Under a testamentary discretionary trust, minors are taxed like adults. With a normal family trust, however, distributions to minors are taxed at penalty rates. The differences are very significant on a sliding scale, from 37% to 45% for distributions of $120,001 to $180,000, to 0% to 66% for distributions of $417 to $1,307.
When income earned is streamed to minors through a testamentary discretionary trust, the beneficiary benefits from preferential tax rates. Under this arrangement, income can be streamed to students and low-income adults for similar tax benefits.
4. Homes and Investment Properties
In a common scenario, the testator passes away with one significant asset — the family home. The management of this asset through the will can have a huge impact on the future income and prosperity of the beneficiary and their family. For example, if the home is worth $1,000,000 and the testator has a single beneficiary, the difference between a simple and smart will can be significant.
In this example, the beneficiary earns $120,000 annually, has two children in school, and rents their home. Once the testator dies, the home passes to the beneficiary and is rented out to provide a source of regular income. If the home is held as an investment for 10 years before selling for $1,250,000, the beneficiary earns $250,000 on the sale. If the beneficiary rents out the home during that time for $50,000 per year, they can benefit from greatly reduced taxation.
The beneficiary's annual employment and rental income is $170,000 in this situation. This puts them in the $120,001 - $180,00 tax bracket, which has a rate of $29,467 plus 37c for each $1 over the lower limit. The beneficiary must pay an extra $18,500 tax each year due to income from the property, with this number rising to $300,000 in the year of the sale.
The smarter option
In an identical financial situation, but with a testamentary discretionary trust, the beneficiary can greatly reduce their tax obligation. With this arrangement, the beneficiary splits the rental income among her two children, saving thousands of dollars each year in tax and avoiding the top tax bracket in the year of the property sale for savings of more than $150,000.
5. Asset Protection
Asset protection is an important element of every will. To avoid future financial problems and even bankruptcy for your beneficiaries, it is important to create a testamentary discretionary trust. All assets in your beneficiary’s name are vulnerable to claims from current and future creditors. If they make a bad investment decision, your hard-earned assets may be vulnerable.
Family law claims can also be affected by your will arrangements. If your beneficiary is involved in a marriage or relationship breakdown, ex-partners can make claims against your hard-earned assets. Placing your assets in a testamentary discretionary trust controlled by a trustee is a great way to separate and protect diverse property assets.
Foreign Beneficiaries
When the will-maker passes away, capital gains generated for applicable assets are disregarded unless they are passed to an "exempt entity". An exempt entity is a foreign resident for Australian tax purposes. When a standard simple will is used for a foreign beneficiary, capital gains tax (CGT) is triggered. With a testamentary discretionary trust, however, CGT can be eliminated.
6. Centrelink Entitlements
Many Centrelink entitlements have asset and income test requirements, which can be affected by your will. Setting up a trust helps your beneficiaries to meet these requirements and maintain welfare eligibility. The following trust structures help to protect Centrelink entitlements:
Beneficiary Support Trust
A Beneficiary Support Trust is a special trust created for a single beneficiary. It is also known as a Capital Protected Trust or Protective Trust. The designated beneficiary has no control over the allocation of assets, which makes this arrangement ideal for people with disabilities or addiction issues. This arrangement also reduces the risk of the beneficiary losing their welfare entitlements.
Special Disability Trust
A Special Disability Trust is created for a beneficiary with a severe disability. The details of this requirement are created by the Department of Social Services. If the beneficiary is deemed to have a severe disability, assets in the trust are exempted from means testing by Centrelink and the Department of Veterans’ Affairs.
7. Flexibility for Beneficiaries
When creating a will, it is vital to keep options open for your beneficiaries. Short and simplistic wills often do the opposite, forcing people to receive gifts and deal with taxation directly. Wills with testamentary trusts give your beneficiaries the freedom of choice. They can decide whether to take the assets directly or via a testamentary discretionary trust based on their circumstances and preferences.
A simple will presents the following risks:
Places your hard-earned assets at risk by exposing them to claims from creditors.
It prevents your beneficiaries from taking advantage of tax savings from income streaming.
8. Inclusions and Exclusions
An astute will needs to be explicit about inclusions and exclusions. Any "eligible person" can apply for a family provision order under your will when you pass away. In this situation, your intentions may not be respected. An "eligible person" includes anyone you were responsible for over your lifetime, including children, grandchildren, dependents, former spouses, de facto partners, and people living in your home. To avoid this situation, you can exclude specific people from your will and note the reasons.