Family wealth, the next generation and relationship breakdowns
Baby boomers have been able to build their wealth and they are now the wealthiest generation in Australia’s history. Their over-riding concern is how they can transfer their wealth to the next generation without it being `lost’ to individuals outside the family group as a result of relationship breakdowns.
Similarly, blended families are a growing group in our community and they too have a special need to ensure that family wealth is passed on as intended.
If you are one in one of these two groups of people, you should be aware of the ever growing `reach’ of the Family Court and its potential to interfere with your family wealth and businesses succession planning. Any discussion about asset protection, wealth transfer and business succession planning must therefore include family law considerations.
There are four issues that impact on asset protection and inter-generational wealth transfer:
- Structures used to protect/hold family wealth;
- Personal relationships with people outside the family;
- Wills; and
- Estranged family members
Structures used to protect/hold family wealth
The most common structure your financial advisor or accountant will recommend is a family trust.
In a family trust there is trustee, an appointor (or principal) and beneficiaries. Very often the children in a family will be included as beneficiaries. So too will the parents who while often not baby boomers at the time the trust is created, are currently baby boomers and the children are adults. This creates the opportunity to provide benefits to the children by way of trust distributions but without those children having any formal control over what they might receive or when.
The family trust’s main reasons for being is to hold assets and income split between family members to minimise the tax payable by those family members. A trust is created when someone (the settlor) transfers assets to a trust. In modern trusts, the asset is usually a cash payment of $10 or $50. This is sufficient to create the trust. The reason for this small sum is that stamp duty is payable on assets that are transferred to a trust. Once the trust is created assets of a greater value are then transferred.
A trust structure is very useful to protect assets against bankruptcy and creditors of beneficiaries. This is because it is the trust that owns the assets and not the beneficiaries. It is this legal principle that prevents a creditor (or the trustee in bankruptcy) of a beneficiary from accessing the assets of the trust in payment of a beneficiary’s debts.
Similarly, a creditor of the trustee or an appointor /principal of a trust cannot access the trust assets for the same reason. The trustee and the appointor do not own the assets held in the trust.
While a trust structure is very useful for tax minimization and asset protection, without specialist advice and careful structuring a trust is generally not useful to protect assets against an order of the Family Court.
To give you a most unlikely example, in 2008, one Dr Spry, a leading legal authority on trusts in Australia at the time, came off second best in an argument with the Family Court and the High Court over a trust he had created in 1968. He made the mistake of relying solely on commercial trust law principles and completely overlooked or he disregarded he power of the Family Law Act to cut through trust law principles. This decision and an earlier commercial case from West Australia (“Richstar”) have served as a warning to advisors and their clients.
In case you might think this is an isolated case, since this decision, there have been a number of cases where the comments of the High Court Judges in the Spry case have been relied on by the Family Court to find that trust assets are available to be divided between spouses.
That said, it is possible to `family law proof trusts’ in certain situations. This is by being careful with setting up a trust. This includes choosing very carefully who is to be in effective control of the trust, the source of the assets to go into the trust and the terms of the trust deed. It is highly desirable to put such a structure in place well before the children are old enough to be in relationships. However, as Dr Spry discovered, setting up a trust very early is not sufficient on its own.
We strongly recommend that a specialist in family law is consulted in setting up the trust structure (or amending an existing trust it if possible) to advise on what needs to be done to make it as difficult as possible for the Family Court to attack a family trust.
These funds are a trust but they have a different purpose and structure to a family trust. There are two main types which are a self-managed fund and a commercial fund. Under the Family Law Act, superannuation entitlements are treated as a form of property and so are not protected from the reach of the Family Court. Apart from a Will which only operates upon a person’s death and a binding death nomination, the only way to protect superannuation is to hold it in a self-managed fund and quarantine it by way of a financial agreement. The payment of superannuation benefits held in a commercial superannuation fund is less amenable to control as the payment is determined by that fund’s trustee in the absence of a binding death nomination.
Personal relationships with people outside the family
Inheritances received either before or during a relationship are usually available to be divided between spouses/ partners in a divorce settlement. In certain circumstances, future inheritances can also be taken into account in an indirect way by the Court regarding them as a `financial resource’. The effect of this is usually for the other party to receive more by way of assets to compensate them for the lack of a similar financial resource.
Therefore, based on what has been said so far, it goes without saying that it should be part of the family business protocol (and part of whatever agreements are in place that regulate family member’s roles in the business) that where there is an intention to enter into a marriage or a defacto relationship, there should be a requirement to enter into a financial agreement as a precondition to receiving any benefit from the business. This same advice applies to parents who are wanting to transfer significant wealth to their children.
If the parties are young and/or they intend to have children then the financial agreement must provide adequately for the outside spouse/partner in the event of a separation.
If this is second time around for the parties then the issues associated with blended families arise and the best way to manage the expectations of all parties is to establish the rules early with a financial agreement.
A Will only operates upon the death of the person who made the Will.
The Will of a member of a family business must preserve the family business and form part of the overall plan for family wealth transfer to the next generation. It is an essential partner to a financial agreement, an enduring power of attorney and the agreements between family members that formalise their relationships with each other within the business. These are the suite of documents all family businesses and members need for the protection of the family wealth and its transfer to the next generation as intended.
The Will of each of the parents or head of the family business will normally contain a testamentary trust. This is simply a trust established under a Will. A Will can establish more than one testamentary trust. Often this type of Will is criticised as the will maker trying to control from the grave.
Such a trust is very useful when
- The estate is considerable;
- The beneficiary needs protection. This can be a risk of bankruptcy, suffering a disability, mental illness or a risk of a breakdown in a personal relationship; or
- The beneficiary is a minor.
The testamentary trust works by delaying the transfer of capital wealth to the beneficiary at the discretion of at trustee but in the meantime paying income to the beneficiary by the trustee who has the discretion as to how much to pay and how often.
A will maker can require a beneficiary to enter into a financial agreement as a condition of receiving an inheritance from the will maker’s estate. This could be used as an alternative to a testamentary trust or in addition to such a trust in the Will. While this is an extreme example of `ruling from the grave’ in some cases it may be warranted. Without such an agreement, there is a risk that the assets held in a testamentary trust will be regarded as a `financial resource’ available to the beneficiary. As stated above, the effect of this is usually for the other party to receive more by way of assets to compensate them for the lack of a similar financial resource.
Estranged family members
Family members become estranged most commonly through mental illness, drug, alcohol or gambling addiction and where they have partners who do not get along with family members.
The question becomes how to manage these family members while perhaps enabling them to enjoy the financial benefits of being part of the family group. This problem requires the assistance of outside advisors as there is usually high emotion that needs to be managed in these situations. The most common way of dealing with such family members is to include them as a beneficiary in a family trust but their entitlement is to income only and not the assets of the trust.
The greatest risk from estranged family members is upon the death of a parent where that parent may have excluded the family member from their Will or only left them a limited inheritance, often for very good reason. It is common for such members to contest their parent’s Will because in their mind their parent has not made adequate provision for them in their Will.
If a parent wants to provide for an estranged child who has an addiction problem, this can be done through a protective trust under the Will. Under the terms of this trust, the child will never take control of their trust unless the trustees agreed it would be appropriate for the child to do so. Clearly care needs to be taken in who would be appointed as trustees of this trust to manage the affairs for the problem child. The trustees could be the same people who are executors of the parent’s Will.
Certain protections can be put in place. This protection starts with obtaining expert advice from a family lawyer on how best to `family law proof’ the family assets or how to provide for this as part of succession planning. The protections include
- formalising loans given to adult children by way of a loan agreement. Read more about this topic.
- ensuring that adult children do not hold positions of control in a family trust;
- requiring adult children to have a financial agreement with their partner/spouse in place; Read more about financial agreements.
- ensuring that you have an up to date Will and Enduring Power of Attorney
We, at Damien Greer Lawyers have the skills to provide such advice and we work with estate lawyers and/or commercial lawyers to achieve the best outcome for clients.
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