How to operate a 3-Generation Testamentary Trust Will

A 3-Generation Testamentary Trust is a sophisticated and highly flexible estate planning tool designed to provide significant tax advantages and robust asset protection for your family across multiple generations. This comprehensive guide outlines what these trusts are, their major benefits, and the process for setting them up and customising them after the Will Maker has passed away.

Understanding the 3-Generation Testamentary Trust

Invented by Professor Brett Davies, the 3-Generation Testamentary Trust is a discretionary trust created within a Will. It only comes into existence after the Will Maker has passed away. Its structure offers significant flexibility and protection. Key features include:

• Tax Efficiency: The trust structure is designed to be highly tax-effective, providing significant advantages for beneficiaries.
• Asset Protection: It includes powerful mechanisms like a “Divorce Protection Trust,” which can be activated to shield a beneficiary’s inheritance from claims during a separation or divorce. Provisions also exist to protect assets for beneficiaries who may be bankrupt, under 18, or otherwise vulnerable.
• Flexibility: Beneficiaries have the discretion to choose whether to establish a trust for their inheritance. The trust can also be wound up when it is no longer needed, allowing for adaptable financial planning that suits changing individual circumstances.

The Tax Advantages of a 3-Generation Testamentary Trust

The appeal of a 3-Generation Testamentary Trust lies in its tax-effective structure, which provides a suite of benefits for managing income and capital gains.

1. Strategic Management of Capital Gains Tax (CGT)

The discretionary nature of the trust offers powerful tools for managing CGT on estate assets. The trustee can “stream” capital gains to beneficiaries who are best placed to absorb the tax, such as those with low incomes or existing capital losses. The trust also benefits from the 50% CGT discount for assets held over 12 months.

2. The Family Home and the Main Residence Exemption: A Critical Decision

The treatment of the deceased’s main residence requires careful consideration, as a valuable tax exemption can be lost.

• The Two-Year Disposal Rule: Australian tax law generally allows a beneficiary who inherits a main residence to sell it within two years of the date of death without incurring any CGT on the capital growth since the date of death.
• The Trap: Transferring the Home into a Trust: If the executor transfers the family home into a 3-Generation Testamentary Trust, this valuable CGT exemption is immediately forfeited.
• The Strategic Advantage of Discretion: The 3-Generation Testamentary Trust provides the solution. The beneficiary is not forced to put the home into the trust. They can choose to inherit the home directly in their personal name to preserve the two-year, CGT-free sale window. Other assets can be placed into the trust to gain its benefits. This allows the beneficiary to make the most tax-effective choice for each asset.

3. Favourable Tax Treatment for Minors (Children Under 18)

A significant benefit of a 3-Generation Testamentary Trust relates to income distributions to beneficiaries under 18.

• The Problem: Division 6AA and Penalty Tax Rates: Ordinarily, “unearned” income paid to a minor is taxed at penalty rates up to 66% above a small threshold (currently $416) under Division 6AA of the Income Tax Assessment Act 1936.
• The Solution: The Section 102AG “Excepted Trust Income” Exemption: Section 102AG provides a key exemption. It classifies income from a deceased estate as “excepted trust income.” As a 3-Generation Testamentary Trust is created from a Will, any income it distributes to a minor qualifies. This means that a minor beneficiary is taxed at the same marginal tax rates as adults. They can receive up to the standard tax-free threshold (currently $18,200) tax-free, which is an effective way to fund expenses like school fees.

Obtaining a Grant of Probate

Before any trusts can be established from the Will, the executor must first obtain a grant of probate from the Supreme Court. This legal document confirms the Will’s validity and gives the executor the authority to manage and distribute the deceased’s estate. With a Legal Consolidated Will, this process is designed to be straightforward, and the firm offers free guidance to executors.

Setting Up and Customising the Trusts in the Willmaker’s Will

Once probate is granted, the executor can proceed with establishing the 3-Generation Testamentary Trusts.

1. Beneficiary Control and Multiple Trusts: Each primary beneficiary can establish one or more trusts to receive their share of the inheritance. For example, a beneficiary could establish a separate 3-Generation Testamentary Trust to hold a high-risk business, quarantining it from other assets.
2. Naming the Trust: The Executor or the Primary Beneficiary has the discretion to name the trust. This allows for clear identification, such as the “Kenway Construction Trust”.
3. The Formal Trust Establishment Process: The 3-Generation Testamentary Trust Will itself contains the terms of the trust. The Grant of Probate provides the executor with the legal authority to act. One photocopies the Grant of Probate to create the trust. The correct procedure involves the executor using their authority to:
   • Apply for a unique Tax File Number (TFN) for each trust.
   • Apply for an Australian Business Number (ABN) and register for GST if the trust will conduct business.
   • Open a separate bank account in the name of the trust.
4. Amending and Updating Trusts Over Time: A 3-Generation Testamentary Trust is a dynamic vehicle. A solicitor can assist in amending the trust over time for purposes like succession planning or tax planning. This may include appointing backup Appointors and other trustees to ensure the smooth, long-term management of the trust.

Seeking Professional Advice

When dealing with an estate, seek the services of your accountant, financial planner, and deceased estate lawyer. Legal Consolidated specialises in taxation and superannuation. It does not work in the area of deceased estates. However, you, your lawyer, accountant, and financial adviser are welcome to contact the firm for free advice on the 3-Generation Testamentary Trust Will to ensure it is implemented correctly as part of a cohesive estate plan.