Is your son having problems in his marriage? Is your daughter involved with a partner you don’t trust?

These situations are common and can result in your in-laws receiving a benefit from the assets you have spent a lifetime building!

Things become even more complicated if your children divorce and the inheritance becomes an issue in the divorce proceedings. The Family Court will generally only consider inheritances, or future inheritances, when the Will maker is either already deceased or has permanently lost the capacity to alter their Will. By this time you are unlikely to be in a position to assist or have any influence over whether the inheritance is an asset that gets divided as part of the divorce.

Careful consideration of the content and structure of your Will and other Estate Planning documents while you have the capacity to do so is extremely important. A Testamentary Trust, which is established by your Will, can be a useful mechanism to assist in protecting your assets for your direct bloodline. You should, however, ensure that you obtain detailed legal and financial advice about the content and structure of a Testamentary Trust. This is especially important where future divorce or separation is a concern, as the Family Court has wide-ranging powers to deal with Trust assets as part of a family law property settlement, including those held within a Testamentary Trust.

What can the family court do with trust assets?

The Family Court will not simply accept the existence of a Testamentary Trust as meaning that any property held within that Trust is excluded from consideration and potential division in property settlement proceedings.

The Family Court will generally categorise Trusts (and the assets held within them) as being one of the following:

  1. Property of one, or possibly both, of the parties.
  2. A Financial Resource of one of the parties.
  3. Neither, and therefore excluded from consideration in property settlement proceedings.

The Family Court accepts the general principle that the entitlement of a beneficiary of a Trust, including a Testamentary Trust, is only to the proper administration of the Trust. However, where a beneficiary also has effective control or influence over the decisions made about the operation of the Trust, including distributions made to beneficiaries, the Court can infer a greater entitlement or value to that beneficiary’s interest. Depending on the extent of control and influence, including consideration of the historical administration of, and distributions from, the Trust, the Court may find that the entitlement of the beneficiary is more akin to actual property than an undefined interest.

When might trust assets be property?

The assets of a Trust are more likely to be considered property if the Court finds the Trust is a “sham”, an alter ego of one of the parties, or one party has effective control over the Trust in terms of management of the Trust and/or distributions to beneficiaries. Factors such as, who is the Appointor, who are the Trustees, who are the beneficiaries or categories of beneficiaries, the history of how the Trust has been administered and who has received distributions will all be considered.

A party must be a beneficiary or have some capacity to benefit from the assets of the Trust for those assets to be considered as property. Control of the Trust alone is not sufficient, although it may still be considered a financial resource.

If the Court finds the interest in the Trust is property then it is likely to be added into the pool of assets to be divided between the parties in the family law settlement.

When could trust interests be a financial resource?

Trust assets may be considered a financial resource if the Court is not satisfied that a party can or has treated the Trust and Trust assets as their own assets, but is satisfied the party is likely to receive considerable benefit from the Trust in the future.

To be considered a financial resource it is unlikely that a party would be the Appointor or sole Trustee. If they are a Trustee, then they should at least be one of a number of Trustees all of whom actively participate in the administration of the Trust. Similarly, if a party is only one of a number of beneficiaries and, historically, has received some but not all of the distributions from the Trust, then this may assist in persuading the Family Court that the Trust interests are a financial resource, as opposed to property.

If the Court finds a party’s interest in a Trust is a financial resource then it will not be included in the pool of assets for division but will be considered in terms of that party’s ability to support themselves in the future – which may impact on the division of the other assets in the marital pool.

Can trust interests be excluded completely?

An interest in a Trust may be excluded as either property or a financial resource if a party has no control over the Trust, that is they are not the Appointor or Trustee and they do not have considerable influence over those people/entities or the decisions made by them in the administration of the Trust. To be excluded as an asset or financial resource it is also unlikely that the party would have received any significant distributions from the Trust in the past.

If not completely excluded, Trust interests in these circumstances may be considered a financial resource but the “value” attributed to the financial resource is likely to be considerably lower if the party has no or only minimal ability to control or influence the distributions from the Trust and no history of regular or significant distributions.

Some Examples

Scenario 1

John inherited money from his father, through a Testamentary Trust, less than a year after he married Susan. John and his two sisters were the trustees of the Trust. The Trust distributed two thirds of the Trust assets, one third to each of John’s sisters and/or their children. The remaining one third of the funds remained in the Trust when John and Susan separated nine years later. Susan argued that the Trust should be included as an asset of the marriage.

The above was the situation considered by the Family Court in Lovine & Connor [2011] FamCA 432. The Court considered not only the construction of the Trust but also how the Trust had actually been operated. The Court found that while the Husband was only one of three Trustees, his sisters had played no active role and the Husband had effective control of the Trust. The Court was satisfied that the Husband would ultimately distribute the remaining one third of the Trust funds to himself and/or his children. The remaining Trust assets were therefore included as assets of the marriage although the Husband was awarded a higher percentage of the assets, partly because the Court accepted that the Trust was an asset to which the Wife had made no contribution.

Scenario 2

Ben’s mother, Rosemary, died two years after he and Cathy had separated but before they had completed the division of their assets. Rosemary left funds to Ben, and his two children, through a Testamentary Trust. Rosemary appointed her solicitor and Ben’s sister as Trustees of the Trust. Cathy argued that the Trust funds should be included as an asset to be divided between them as part of their property settlement.

The above was the scenario faced by the Court in Ward & Ward [2004] FMCAfam 193. The Court again considered the construction and operation of the Trust. The Husband ultimately admitted to the Court that he believed the purpose of creating the Testamentary Trust had been to put the inheritance out of the reach of the Wife. The Court found that it was probable that the Husband would receive the full benefit of the Trust but elected to treat the Trust as a financial resource of the Husband rather than an asset of the marriage, particularly as no actual distributions had been made by the Trust and it had been acquired after separation. A greater adjustment of the marital assets was however made to the Wife on account of the Husband having this significant financial resource.

Scenario 3

Anne’s father, Ray, died almost four years after she had separated from George. Anne and George had not completed their property settlement at the time Anne’s father died. Ray’s Will created four Testamentary Trusts of which Anne, her mother and her three siblings were beneficiaries. The Trustee of each of the Trusts was a company. Anne, her mother and her three siblings were all Directors of that company. Anne’s mother was the sole Appointor of all four Trusts. George argued that Anne’s interest in the Trusts was an asset or, at least, a financial resource of Anne’s and should be considered as part of their property settlement.

The Court considered the above scenario in Carmel-Fevia & Fevia (No. 3) [2012] FamCA 631. The Court held that the Wife had no absolute right to any particular share of the Trust assets. The Court also held that the Wife had limited control over the Trust as she needed the consent of her mother and all three of her siblings before she could receive any benefit or distribution from the Trust. Ultimately the Court determined that whilst the Trust was likely a financial resource of the Wife, because the power of the Wife to control the Trust was limited, it would not give any significant weight to the Wife’s interest in the Trust when deciding the property settlement matters.

Interestingly, in this case, whilst the total funds held in the Trusts were approximately $7 million the other assets of the marriage totalled approximately $434 million. The Court commented that the size of the Trusts were very modest in comparison to the other assets. This may well have influenced the decision of the Court to not attach significant weight to the Trust interests.

Things to remember

When creating a Testamentary Trust, particularly where current or future family law proceedings are a concern, the following are particularly important:

  • Who will be the Trustee? – The more independent the Trustee or Trustees the more protection Trust assets are likely to have in any family law proceedings.
  • Who will be the Appointor? – This is the person who has the power to add or remove a Trustee and is a powerful position to hold within a Trust. The more independent the Appointor, the greater the protection from a family law perspective.
  • Who will be the beneficiaries? – If there is only one beneficiary or one discrete category of beneficiaries (such as a child and their children) then it is more likely that the Family Court would infer that the Trust assets are effectively held by that person as property.

Careful consideration of the above, including obtaining proper legal and financial advice specific to your circumstances, is extremely important. The use of Testamentary Trusts cannot guarantee an inheritance will be excluded from consideration in family law proceedings but careful construction of the Trust can provide the best protection against assets ending up in the hands of unintended and unwanted beneficiaries.

Why use a testamentary trust?

Testamentary Trusts provide a useful mechanism for managing and controlling the distribution of your assets after death. Apart from assisting in a family law context, Testamentary Trusts can provide benefits in a number of other ways, including:

  • Taxation – As the distribution of income and/or capital to beneficiaries is usually discretionary, this can allow a Trustee to distribute funds in the most tax effective manner.
  • Asset Protection – In addition to providing asset protection in a family law context, a Testamentary Trust can assist in protecting assets for beneficiaries who are in difficult financial circumstances, are spendthrift, are under some form of incapacity or are in a business or high-risk profession where personal negligence claims can arise.
  • Flexibility – Distributing assets to beneficiaries through a Testamentary Trust can provide significant flexibility both in terms of the types of assets that are distributed to particular beneficiaries and when those distributions are made, so that the funds actually received by beneficiaries is maximised.