|
Baby boomers, the wealthiest generation in human history, are
writing their wills. Tax agents who do not recommend the use of
testamentary trusts to these wealthier clients are failing to act
in good faith and provide proactive and sound tax advice. This is
because from an estate planning perspective, testamentary trusts
offer almost endless flexibility.
The most fundamental advantage of testamentary trusts is the
opportunity for tax savings they provide as a result of the
concessional tax rates afforded to them.
The use of a testamentary trust allows beneficiaries of the
trust who are under 18 years old to have the benefit of adult
income tax marginal rate scales (compared to the usual penal rates
that apply to such income under Division 6AA).
A properly structured testamentary trust can thus ensure that
income tax is effectively distributed to the deceased’s children
or children’s children. Tax is saved by splitting income across
one or more minor beneficiaries, rather than adults who are taxed
at the top marginal tax rate.
Acting smart
In the absence of a testamentary trust, if a person simply
leaves their personal wealth to their children, it is the deceased’s
children who bear the tax burden associated with the inheritance.
The deceased’s children will have no other option than to
support their own children from birth to adulthood out of money
that has been subject to tax at 48.5% (assuming the deceased’s
children are in the highest marginal tax bracket).
The use of a testamentary trust, on the other hand, alters the
tax outcome for the beneficiaries of the deceased estate
significantly. By setting up a testamentary trust, the deceased’s
assets can be distributed to beneficiaries in a manner that
ensures that the deceased’s grandchildren can be brought up with
money that has been taxed at marginal tax rates.
Jane and Jill are both 80 years old; they each have four young
grandchildren (below the age of 18) and want to leave their
respective grandchildren with a $2 million inheritance. Jane’s
tax adviser recommends that she set up a testamentary trust. Jill’s
adviser does not.
On Jane’s death, the $2 million funds are vested in a
testamentary trust. The trustee of the trust invests the $2
million funds and distributes the income of the trust evenly to
Jane’s four grandchildren. Assuming her grandchildren receive
distributions of trust income amounting to $400,000, taxed at the
marginal tax rates applicable to adults, the total tax on the
distributions will be $128,500 (i.e. distributions to each of the
four grandchildren of $100,000 taxed at marginal tax rates).
On Jill’s death, her four grandchildren receive $2 million
(i.e. $500,000 each). The grandchildren invest these funds,
generating $100,000 of income per grandchild. The total tax
liability arising on this income is $194,000 (i.e. four
grandchildren with $100,000 income each). As all her grandchildren
are under 18 years of age, income generated by their investments
is taxed at 48.5%.
Jane’s grandchildren are better off by $65,600.
A good testament
The flexibility afforded by testamentary trusts has a number of
additional benefits. As testamentary trusts can be tailored to
meet the specific needs of each person, they can also be created
to extend over a number of generations, allowing the deceased to
have influence over the assets for a period beyond that usually
available.
Similarly, the use of a testamentary trust shifts control over
assets from beneficiaries, who may be at risk of misusing the
funds, to an independent trustee with investment expertise.
This way the beneficiaries are able to receive a specified
income stream from the trust whilst the value of the assets is
preserved, or even increased through investment. The money can
then be distributed once the children have reached a certain age.
The topic of testamentary trusts is covered in detail in
Thomson’s Australian Financial Planning Handbook (AFPH),
which will be of interest to readers who require greater detail on
this topic (as well as the topic of financial planning more
generally).
AFPH discusses and explains — with checklists, examples, and
case studies — both the benefits and disadvantages of these
trusts from an estate planning, social security and general
taxation perspective. To find out more about AFPH, simply call
1300 304 197 or email us at LRA.support@thomson.com.
This article appeared in Thomson’s InTax (February 2006)
InTax is Australia’s best independent monthly tax
magazine. It provides concise reports of the latest tax news, plus
the practical implications of tax developments in an easy-to-read
magazine format. Phone Thomson Customer Service on 1300 304 197 to
find out more.
Return to TOP
|
