03/03/2015

Just because the testator has died, don't think it is too late to establish a testamentary trust.  

If the deceased had minor children it is possible to establish a so-called testamentary discretionary trust for the benefit of those minor children (and therefore the family as a whole) up to 3 years after the death of the deceased (s.102AG(d)(ii) Income Tax Assessment Act 1936).

The beauty of a testamentary discretionary trust is that minor children can earn up to the normal adult marginal rate before paying the relevant tax percentage.  Contrast this to an ordinary family trust where the minor children pay penalty tax on any income over $416.

So, for example, let's assume that Dad passes, leaving Mum and three minor children.  Mum's financial adviser tells her to set up a discretionary trust with the money from Dad's estate. Mum will either be the trustee of the testamentary discretionary trust or at least control the trust.

She can then ensure that the payments for the children's lifestyle such as education fees, living expenses, holidays etc come from distributions of income earned by the trust.  In that way between the three children and herself, the family will be able to earn up to 4 times the current tax-free threshold (ie around $72,800) before paying any income tax.

However, the news is not all good.

If the testamentary discretionary trust is set up after Dad's death there is a limit to the amount of principal that can be used to earn this excepted trust income for the minor child.  The limit is the amount that the child would have received if Dad had died intestate (ie without a Will). That means the amount will be different in different States because the intestacy laws differ for each State.

So, assume that the family lives in NSW and Dad dies without setting up a testamentary discretionary trust under his Will.  Under the NSW intestacy provisions Mum receives the whole estate and the children receive nothing.

That means that effectively no amount could be allocated to the minor children under a testamentary discretionary trust set up after Dad's death, and the strategy fails.

If he had set up the trust in his Will the family would have benefitted very materially. It is therefore crucial (in NSW at least) to establish these arrangements in Dad's Will and not rely on the vagaries of the intestacy laws.  

Yet another reason, if one was necessary, for why it is important to get good estate planning advice before it is too late. For further information, contact Townsends Business & Corporate Lawyers now on (02) 8296 6222.