It is a fact, we are now dealing with more blended families on a daily basis that it is often a surprise when we meet with the generic “vanilla” family. Moreover, with the baby boomers looking towards their retirement years, there has been an increase in the importance of protecting their hard-earned assets as well as the futures of their seemingly “spendthrift” children and grandchildren.
One of the strategies that can be implemented by these clients is to establish a capital protected trust during their lifetime or to incorporate a capital protected testamentary trust in their will.
What is a capital protected trust?
A capital protected trust is a trust which allows for the income of the trust to be distributed to a primary beneficiary or class of beneficiaries (ie: income beneficiaries), while the capital of the trust is reserved or protected for a period of time for a primary beneficiary or for another class of beneficiaries (ie: capital beneficiaries).
It is generally used where a client wants to provide a benefit for his or her second spouse during that spouse’s lifetime but the client wants to ensure certain assets or the capital of the trust is protected for the children of the client’s first marriage.
Increasingly, however, situations have arisen where clients are incorporating a capital protected trust in their wills for a child or children that they believe will not grow out of their “irresponsible phase” or spendthrift ways until they attain the age of 50, for example. Once the child attains the age of 50, then the trust will terminate and the capital is distributed to the child or the child will take sole control of the trust to make distributions at his/her absolute discretion. Clearly, considering the tax effectiveness of such terminations needs to be undertaken.
In a capital protected trust, the income beneficiaries are generally similar to the beneficiaries of a family trust – ie: a primary income beneficiary as well as a fairly broad class of beneficiaries. This means the trustee has the discretion to choose amongst the income beneficiaries to make distributions to each year. Capital beneficiaries, on the other hand, are not discretionary beneficiaries of the capital protected trust – ie: the trustee cannot exercise discretion and must pay the capital of the trust fund to the nominated capital beneficiaries. With that said, capital beneficiaries do not usually have access to the capital of the trust until the death of the primary income beneficiary.
Control over the capital
Although there are inflexible capital protected trusts where the trustees have no control over the distribution of the capital and only have access to the income, there is the possibility to incorporate terms in the trust to allow the trustees to have some discretion to access part of the capital.
For example, this discretion would be useful to maintain the lifestyle to which the client’s second spouse has become accustomed. It could also be useful for trustees to have discretion to access the capital of the trust established for a client’s child – it may be the child has expressed the desire to undertake further education or training and the income generated by the trust is insufficient to meet the child’s education costs.
In these instances, the client can make an express allowance for some capital to be distributed to the surviving spouse or child (as the case may be) if the trust income in any financial year does not meet a specified amount. Any restrictions, qualifications or even percentages on the distribution of the capital can also be included.
Capital beneficiaries, generally, do not have access to the capital of the trust until the death of the primary income beneficiary or until a condition of the trust is met.
In the case of blended families, it is important that clients consider the age of the ultimate capital beneficiaries (eg: children of the first marriage) relative to the age of the primary income beneficiary (ie: the step-parent). If the step- parent is significantly younger than the client, then the client’s children may need to wait some years before they can access the capital of the trust. Although the client has made provision for his/her children, there is still the potential for conflict and for those children to make a family provision application.
In relation to a “spendthrift” child, there is also the potential for dissatisfaction leading to that child making an application to the court for the trust to be wound up and for the capital of the trust to be distributed to him/her absolutely.
Therefore, the need for careful consideration, advice and drafting of relevant documents need to be applied.
There are a number of estate planning strategies available to clients, however, care must be taken so that each situation is assessed in accordance with the client’s individual circumstances, especially where there are risks in relation to potential family provision applications.
Specialised legal advice should be sought to ensure the appropriate estate plan is implemented and representatives from our Estate Law team will be happy to assist with matters regarding succession for blended families, protecting a child’s inheritance and estate planning in general.