30/04/2013

A testamentary trust can offer significant benefits over a simple Will such as a greater level of protection for the beneficiary's inheritance.

While ‘ruling from the grave’ may be excessive and is best avoided, ‘protecting from the grave’ could be a very worthwhile goal.

Take the case of Irene who has two children, George, 35, and Tom, 25. While she thinks that George is fully capable of managing his own affairs, she is concerned that Tom is a bit immature, could be “vulnerable” to marital breakdown or commercial misadventure, and has limited capacity to manage his own finances.

As George has his own family, Irene wants to provide some flexibility in how he is to inherit his half of the estate, but also wants to make sure the assets remain within the family and are used to benefit his young children.

Irene’s Will could specify that it is optional to create a discretionary testamentary trust for George’s half share of the estate. If she wants to provide full flexibility for George’s inheritance, she could name him as the Trustee, appointor and the principal beneficiary. Then if he chooses to take all or some of the assets in the form of a trust, he would control them as his own but will also enjoy the protection afforded by the trust.

This is because the trustee in a discretionary testamentary trust effectively “controls” the inheritance inside the trust by managing the trust assets and deciding who amongst the beneficiaries receives distributions of capital and income from the trust.  

Irene could also specify whether George’s wife Xena is to be a beneficiary under the trust. If Xena is named as a beneficiary, the trustee could pay all or part of the capital and/or income to her from the trust.

On the other hand, the decision in Kennon v Spry (2008) makes it easier for Xena to make a claim on the trust if she is named as a beneficiary.  If Irene wanted to protect her son from this possibility she may be better placed to leave Xena out of the list of potential beneficiaries. She would also then need to ensure that George doesn’t control the trust which she could do by appointing several other trustees to serve with George.

In order to control the distribution of assets to future generations, Irene could specify that establishing a trust is mandatory for a set percentage (say 40%) of George’s half share of the estate.  

Importantly, as the appointor is the person given the power to appoint a new trustee, she could also name a third party as the appointor for the trust.

Finding third party trustees and third party appointors is not without its challenges.

To maximise the chances that assets will survive George for the benefit of his children, Irene could also specify that he can only access a limited portion of the capital assets of the trust in any year, say 5% in total per year.

To protect her younger son Tom, Irene could specify that it is mandatory that Tom’s half share of the estate be placed in a testamentary trust until he at least reaches a certain age, say, 35.

Along with the above control measures of appointing multiple trustees and appointors for the trust, she could also exclude any future spouse of Tom’s from being a beneficiary. Although not a certainty, this may go some way in protecting Tom’s inheritance from being considered as property of a future marriage and not divisible amongst parties in the event of a marital breakdown.

In the event that a beneficiary is temporarily incapacitated, testamentary trusts also enable the assets to be managed by the trustees for the benefit of the beneficiary.

In theory, in a discretionary testamentary trust arrangement, the beneficiary does not have actual entitlement to a distribution until the trustee so determines. This rule has been weakened by the decision in Kennon v Spry but could still mean that if Tom were to go through a period of incapacity, have some solvency difficulties or be bankrupt at the time of distribution, the trustee may be able to retain the assets in the trust for his future benefit, free of any creditor’s claims.

A testamentary trust for Irene’s children can provide the level of flexibility she wants for George’s share of the estate, as well as providing some protection from creditors and management of Tom’s inheritance.  But careful thought needs to be given to all the parameters and certainly an “off-the-shelf” approach will sell Irene short.

For more information, please  Townsends  Business & Corporate Lawyers on (02) 829 66 222 .