The importance of Testamentary Discretionary Trusts and Binding Financial Agreements – Podcast Episode 24

In this podcast, Partner Nadine Udorovic and Senior Associate Kate Bell are joined by Rachael Grabovic, Partner and head of the Wills and Estate Planning Group at Rigby Cooke Lawyers, to discuss wills and estate planning. The lawyers explore testamentary discretionary trusts in wills and binding financial agreements, as well as steps people can take to be proactive from a family law perspective in protecting their assets. Given the uncertain climate of COVID-19, this podcast is particularly pertinent as it explains the financial stability which testamentary discretionary trusts and BFAs can provide, offering some form of certainty during this unprecedented time.

 

Nadine:

Rachael is an accredited wills and estates specialist with extensive experience in wills, estate planning, trusts and estate litigation.  Rachael has worked in both private practice and within corporate industry.  Rachael also has a graduate diploma in financial planning from the Financial Services Institute of Australia and has specialised in recent years in providing personalised succession and planning advice  to high net worth individuals across Australia.

Kate:

It is such an interesting space to be working in, Rachael, thanks for joining us today, and chatting about an area which you obviously find fascinating.  How are you going?

Rachael:

I’m doing very well, Kate. Thank you for the lovely introduction Nadine.  We find ourselves in interesting times.

Kate:

Tell us a bit about your practice, Rachael, typically who are your clients and when do they come to seek your help?

Rachael:

I work with a team of four lawyers who all specialise in this space, so day in and day out, it is wills and estates for us. We do basic wills, to complex estate planning, probates and estate administration to estate litigation.  We also provide advice on trusts and trust litigation and we also go as far as looking at guardianship and administration, how attorneys behaving badly, that sort of thing.  Our clients vary in age, demographics, wealth and background.  In terms of what I specifically do, my work is to find a better word, bespoke estate planning for high net worth individuals and family businesses.  We operate on the basis that everyone deserves good legal advice and an operative will that mitigates any potential for litigation.

So our policy is: “All welcome”.

Kate:

That’s a great policy to have, very inclusive!

Nadine:

That’s wonderful Rachael.  Before the podcast, Kate and I were discussing the similarities between our two areas of practice. There is a lot of cross-over in both realms.  We are often dealing with families in great distress, emotions can run high and family dynamics can be extremely complex. However, there are some steps that people can take to be proactive with wills and estates in family law in protecting their assets, which is a lot of the advice that we do. For example, from a family law perspective, a well-drafted testamentary discretionary trust and a binding financial agreement can be extremely useful tools in protecting the assets of a person. They can also be of great assistance in succession planning and transitioning wealth between generations.

So today, we thought we would chat a little about these legal tools with you, the tools of testamentary discretionary trusts and binding financial agreements, when they are useful and how they can be advantageous.

Kate:

Rachael, for the benefit of our listeners, can you explain what is a testamentary discretionary trust?

Rachael:

Well, I guess most people would know what a family trust is, which is in effect a discretionary trust, so a testamentary discretionary trust is simply a discretionary trust which has been established via a will.  A little bit more information:  a family trust is principally ….what you are doing is separating legal ownership from beneficial ownership, so the legal owner being the trustee of the trust and the beneficial owners being the multiple beneficial owners, so the reason it is discretionary is because there are multiple beneficiaries to a discretionary trust, and the trustee each financial year, has to exercise its discretion as to who is going to receive the income and/or capital of that trust in that financial year, distributing amongst the eligible beneficiaries of that particular trust.

Nadine:

Thank you, Rachael, yes we have a lot of exposure to those in family law matters. Can you tell us what are the advantages of a testamentary discretionary trust?

Rachael:

The main advantage of a discretionary trust in a will is income-splitting.  As some people may be aware, minors or anyone under the age of 18, if they were to receive a distribution from a family trust, the minor would be taxed at penalty tax rates, so the first $413 is tax-free, and then penalty rates kick in so the top marginal tax rate is effectively applied for any additional income distributed to a minor.

One of the great advantages of a testamentary discretionary trust or a testamentary trust in general is that minors are actually treated as adults so they can actually receive the $18,200  tax-free as well as the ordinary adult tax rates thereon. Say for example parents create a testamentary trust for their daughter and that daughter has three young children, she can actually split the income that she inherits or that is generated from her testamentary discretionary trust between her three children and effectively, if the income is no more than $60,000 for that particular year, no tax or minimal tax will actually be paid on the income distribution, whereas if the daughter had had to take the income herself and she was also employed or has her own business, effectively she may be paying tax at the top marginal rate, and losing close to 50% of that income in taxes.  So there are some great tax incentives in setting up a discretionary testamentary trust.

The other is asset protection, and asset protection for bankruptcy, and if we also look at asset protection from the aspect of someone who might be a gambler, a drug addict or have a disability so protecting the assets for that individual to ensure that their income and assets are protected for them into the future – ensuring that they have a roof over their head and they have got a steady income moving forward.

So the two main advantages are income-splitting amongst the multiple beneficiaries and asset protection.

Nadine:

That’s great and good to know, specially about those tax advantages and so forth, you can see how that would benefit a lot of people – we will talk about some case studies in a minute.  So Rachael, who should consider incorporating a testamentary discretionary trust into their will?

Rachael:

That’s a really interesting question because as you would imagine, every client is different in their circumstances so we have to consider each client individually. But generally-speaking, the most important component is whether there are sufficient assets coming into the estate, to actually warrant creating the testamentary discretionary trust. I often talk to clients about what that minimum threshold might be and our general basis is at least $500,000 forming part of each testamentary discretionary trust which we are establishing so for example if the testator has 3 chlidren we would need at least $1.5 million coming into the estate to warrant the establishment of the three testamentary discretionary  trusts.

The other aspect which I think is important is looking at the needs of the actual beneficiary as to whether a testamentary trust will in fact enhance their circumstances or not, so obviously somebody who might be in a risky profession, or if a person has a child who has their own, for example, they might be lawyers or they might be doctors and there is a potential for them to be sued, those individuals may not want to inherit anything personally.  The testamentary discretionary trust is a perfect way of passing on the testator’s wealth to that particular child in a safe environment.

The other might be the fact that the child could be very bad with money or they might be in a rocky relationship and the parents are wanting to protect the assets as much as they can from that relationship collapsing, and as you would be aware, in terms of all the work that you guys do, in those assets….the matrimonial assets or the assets on separation.

So we often look at all those aspects, so it is not just about what the testator wants, it’s really about the needs and circumstances of the beneficiary as to whether a testamentary trust is right for them as well

Nadine:

Yes sure, fantastic.  And I guess, going back to what we spoke about a little earlier, in terms of looking at some case studies (as lawyers, we love looking at case studies!), can you give us a couple of examples of where you have seen a testamentary discretionary trust work to the benefit of a client or a family that would be of interest to have a bit of a discussion about this morning?

Rachael:

So one example I can give you: often clients will say to me, I don’t know what my children will think of me if I put their assets in a trust: I think I don’t trust them, as opposed to leaving the estate directly to the child and this particular gentleman had created two testamentary trusts for each of his daughters and one of the daughters had come in to see me, very angry that her dad had done this, that he didn’t trust her to do as she chose with the inheritance that she was to receive.  Once I sat down with her and explained the purpose of testamentary trusts, how they can work, and how they could be of benefit to her and to her family, her attitude to discretionary testamentary trusts completely backflipped to the point where she said that she would actually like to make an appointment to change her will, to create these testamentary trusts for my kids as well, she thought they were a really good tool.

That is an example of how people have a misconception of how and why trusts are established in wills and often the people think it is about the parents not trusting them when really it’s not, it’s about giving people opportunity.

One other example is – now these clients haven’t died as yet, so I can’t give you how they have actually come about but it’s more about the planning and strategy that we did to assist them, so they had a family business which was owned by a company, and obviously how you own a family business is going to impact on whether a testamentary  trust is right for you, because often they are held in family trusts and trusts are not assets which form part of the estate so there is a bit of strategy and planning around things.

In this particular case, the clients owned their family business in a company so we had actual assets to deal with in terms of the shares that the parents owned in the company. Now the clients in this situation wanted to ensure that their business passed down their blood-line, they didn’t want their son-in-laws and daughters-in-law or anyone else to interfere in the management of the family business or in owning or benefiting from it, because they had worked really hard in building it. So we looked at creating compulsory testamentary discretionary trusts in their wills, with the beneficiaries of the trust actually being limited to the blood-lines, so the only people who could actually benefit from that trust were the descendents of the parents.  Obviously that works when you have got a large enough family where everyone is having children but we can extend that blood-line out laterally to include cousins and things like that if that is what the intentions of the clients are.

The other thing that was interesting with this particular case was that they wanted also to limit their children’s ability to dispose of their interests in the company. If one child wanted to relinquish their interest they had to give the first right of an option to purchase to their other siblings. Again keeping the business within the family. What we had put in place was a shareholder’s agreement which sat beside the will, so when the assets of the family business were to be transferred to each testamentary trust, the trustees and the primary beneficiary of each testamentary trust, so the child of each testamentary trust, there was a condition for them to inherit the family business; they actually had to sign up to this shareholders agreement, so there was a condition on the inheritance which then imposed these restrictions as to how the business was to be run and the directorship of the company, and those sorts of things.

People talk about not ruling from the grave, but this is an example of how you really can!

Nadine:

I was about to say that!

Kate:

It’s really interesting that you raise the example of families involved in business together and also the various interests and intentions that different family members have, you may recall that when we first met at an event hosted by that fantastic organisation that we are all involved with, Family Business Australia, which is a great member organisation providing support and resources to members of family businesses throughout Australia, and on first glance, it might seem a bit of a strange fit for a wills and estate lawyer and a family lawyer that we are reaching out to the business community. However, fundamentally and looking at that recent case study, all businesses are made up of people. Eventually, everyone dies, and many experience family breakdown, so a dispute over a will or a marriage breakdown and subsequent matrimonial property proceedings can destabilise or damage a family-owned business or legacy. I know in the last few years, we have seen more and more people entering into Binding Financial Agreements, or BFA’s as they are commonly known.  Nadine, would you like to explain to the listeners what a Binding Financial Agreement is, and what kind or circumstances might result in people wanting to enter into one of these?

Nadine:

Sure and that is a really good question Kate, it is very topical with regards to our discussion today, because these agreements have been commonly known as Pre-Nuptial Agreements or “pre-=nups”, which can be a little misleading.  A Binding Financial Agreement or a BFA which us lawyers call it for short, is an agreement which is entered into by people in a relationship with the aim of preventing either of them issuing proceedings under the Family Law Act for a property settlement if they separate.  Binding Financial Agreements can be entered into between both married couples and by de facto and same-sex couples.  Basically, not unlike testamentary discretionary trusts, BFA’s are entered into to avoid litigation on the issue of who gets what property down the track, generally when parties separate.

So as I said, BFA’s can be entered into by married couples, de facto couples and same-sex couples.  Many people don’t realise that in Australia a BFA can be entered into before marriage or before cohabitation, also during a marriage whilst parties are living together and also after parties separate.

We do all of these but typically we would do more in the space of prior to a marriage or cohabitation and in the event of a separation.

Kate:

The most commonly-known form of BFA that we see, Nadine, is often the pre-marriage BFA or pre-nup, and many couples are now entering them shortly after they get married but are still in the early stages of their relationship, which is actually good forward thinking, as well.  A BFA can also be used to extinguish either party’s right to spousal maintenance when a marriage or de facto relationship ends, which is an interesting aspect of the agreement.  I know one of our partners refers to a BFA as a bit like relationship insurance: like, you hope you don’t have a crash or your house burns down but if it does, and you have taken out car or house insurance, at least you are prepared, so a BFA is likened a little bit along such lines.  Nadine, who do you think should be considering a Binding Financial Agreement?

Nadine:

That’s a great question, Kate.  So a common misconception is that BFA’s are only for the wealthy and they are certainly are not.  However, it is definitely worth considering entering into a Binding Financial Agreement with your partner if any of  the following may be relevant to you: if you own any real estate, if you own more than say $50,000 in assets, and assets can be across both equity and property, it could be superannuation, it could be motor vehicles, furniture, shares, investments, cash in the bank, it could be really anything.  If you earn more than $100,000 in a year, if you own a business or part of a business, if you have children from a previous relationship, if you expect to receive a significant inheritance, or even if it is not particularly significant, even if you have an expectation to receive an inheritance and you want to quarantine that out of the matrimonial asset pool which otherwise might be up for grabs, for argument’s sake, if you would like to protect that.  Or if you have more than say $50,000 in superannuation.

So take the following examples: we are now living longer and enjoying more active and fuller lives; people who divorced some time ago and have adult children are forming romantic relationships later in life, so we see a lot of second relationships now, where there is a disparity of wealth between the parties and there is a concern that the children of the new spouse might benefit from the relationship when that is not intended.  Parties are entering into so-called “silver nups” to quarantine assets. These are just some of the examples which might be relevant when you might be considering entering into a Binding Financial Agreement with your partner.

Kate:

Another situation which has arisen recently as a result of property prices – adult children are finding it difficult to buy their first home and often a young couple will combine their savings. But even these combined are not enough to purchase a property so one of the parents of one of the children might contribute a significant amount to the purchase price of the property, so then the question is asked: what if the couple breaks up? Is it a gift? Is it a loan? Sometimes litigation results and it is all a bit of a mess.

This issue can be side-stepped completely with a Binding Financial Agreement which in effect, carves out those funds and protects the parent’s contribution and preserves it for their child.

Nadine:

That’s right, Kate, and another example is where there is involvement with business partnerships and for example where one partner in a business is involved in complex and potentially costly family law litigation, the effect on the business as a whole can be disastrous, and we obviously have a lot of exposure to that through our work in the family law space, so a well-drafted and correctly-executed Binding Financial Agreement can provide clarity, predictability and a simple path forward for parties going through relationship breakdown.  So they are really advantageous and beneficial in a lot of circumstances and certainly something that our listeners should be aware of and look into.

Kate:

It might be interesting for our listeners to hear…do potential  family law issues arise with your practice, with many of your clients, when they seek your advice?

Rachael:

It might be surprising for some to hear that we do actually encounter a number of family law components when we are discussing estate planning, when you are dealing with people, people issues arise. For example, we often get clients who may have recently separated but are not yet divorced and are wanting to update their wills. Discussing some of the complications that are there when they are not actually divorced and they don’t have a will, for example, their spouse is still entitled on intestacy to inherit, so dealing with some of those issues and encouraging people to go down the path of the divorce, because from an estate planning perspective, finality of the relationship is really important.

The other issue which comes up is second marriages, and dealing with clients who want to pass over their partner, their new partner, in favour of the children of their first relationship, so often we refer our clients to family lawyers to get the BFA, for example, because we are wanting to protect their assets whilst they are alive, and during their relationship, but then us dealing with the complications of when they die and trying to mitigate any potential risks with the surviving partner challenging the will.  So we often do send clients to protect their assets during the relationship.

The other issue which often comes up is parents coming in to see us wanting to protect the inheritance they leave their children who might be going through separation or a rocky relationship or a divorce and how we might be able to assist in mitigating any inheritance which they leave to their child, forming part of those matrimonial assets.

Nadine:

There is definitely a cross-over there, and one which is really interesting to explore, the way in which the Family Court deals with trusts generally is another fascinating area and one which we might explore in another podcast soon.  But in short you would agree that a well-drafted and properly-executed testators discretionary trust gives people a high degree of protection against a claim made on the assets of an estate, as does a well-drafted and properly-executed Binding Financial Agreement so you can really see how the two areas of the law merge together, and there is often a lot of cross-over there.  So thank you Rachael, that was very informative for our listeners.

So in conclusion, Rachael, if there were three points which you would like to impress upon our listeners today, when they may be contemplating a will, what would they be?

Rachael:

I think the first one would be to get appropriate advice for your particular circumstances from an experienced wills and estates lawyer – we see so many badly-drafted wills that don’t meet clients’ expectations or circumstances, and cleaning up the mess afterwards is a lot more costly to the estate than a well-drafted will.

The second would be: don’t just think about who you want to leave your estate to, but rather how should you leave your estate to those beneficiaries, so whether you give something absolutely to an individual or whether you create a form of a testamentary trust, whether that be a discretionary trust or a life interest or some other type of trust which can protect those assets.

The third one is about who you appoint as your executors, something people often don’t think too hard about, but the person who takes on that role could see the estate run smoothly or could create problems for that estate, so it is really important to think hard about the person you are going to appoint as the executor as this could minimise issues after death.

Kate:

Thanks so much Rachael, that is really good food for thought. Thank you for chatting with us today, it has made me think, I had my will drafted years ago, and after hearing what you have had to say, I think it is about time that I go back and give it the once-over to see if it needs a re-jig.  So I might be in touch.

Nadine:

I agree with that Kate, it might be time for a refresh! Thank you so much, Rachael, that was wonderful. I’m sure our listeners will really get a lot out of today and we look forward to having you back again, maybe to talk about some other issues that we see come up in our areas of law.

 

Disclaimer: Nicholes Family Lawyers intends the information provided in this podcast as general information only, please contact Nicholes Family lawyers if you require specific information and advise in relation to any family law matter.

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