Will Makers and the Bankrupt Beneficiary

The Bankrupt Beneficiary

It is our practice at ADLV Law to send reminder letters to estate planning clients about updating their Wills ‘if things have changed’.  Usually, we mean if there has been a family breakdown, a re-marriage, changes to the gifting or new executors or guardians are being appointed.  However, it is worth noting that sometimes the ‘change’ you should consider is not one that affects you, the Will maker, personally, but rather a change to the circumstances of a beneficiary under your Will.  This includes a beneficiary’s financial status.  The protest rallies held in every major city in Australia in the last two years suggests many people are struggling financially, so what can you do if you have a bankrupt beneficiary? 

A bankrupt beneficiary

Bankruptcy law1 provides, that anything a bankrupt inherits during their bankruptcy period vests in the trustee in bankruptcy.  This means, if a beneficiary is a bankrupt, the executor of your Will must give those assets intended for the bankrupt beneficiary to the trustee in bankruptcy.  These assets will be used to satisfy the demands of the bankrupt beneficiary’s creditors, with only the surplus (if any) going to the beneficiary.  This is not what you intend, so what can you do? 

Testamentary Trusts

The answer lies in how you give assets to a beneficiary.  To go back a step, there are two ways to pass assets through your Will: 

  1. One is to pass the assets outright to the beneficiary.  In this scenario, the assets end up in the personal name of the beneficiary and can be dealt with as they see fit.  All income and gains from the assets accrue only to the beneficiary, and the assets are available to any person who makes a legitimate claim against the beneficiary. 
  2. The other is to package the assets within a testamentary trust for the beneficiary.  In this scenario, the assets are subject to the terms of the trust as set out in your Will.  Income and gains can be spread among a range of beneficiaries, and the assets can benefit from a level of protection against third party claims.  This is because the assets are not held by the beneficiary, but rather by the trustee of the testamentary trust for and on behalf of the beneficiary, with a discretion to distribute to any of the nominated beneficiaries from time to time. 

For these reasons, we recommend that a bankrupt beneficiary does not receive an inheritance directly. Rather, those assets should be held by the trustee of a testamentary trust for the benefit of a pool of beneficiaries, insulating the assets from potential third-party claims made against individual beneficiaries. 

Life Interest vs the Right to Occupy

You may also wish to provide a beneficiary with accommodation under your Will.  This is often done in two ways: 

  1. By giving a beneficiary a life interest in a property that allows the beneficiary to either live in the property or to generate income from it for their lifetime; or 
  2. By giving a beneficiary a right to occupy a specific property with the property reverting to your estate on the death of the beneficiary. This right is sometimes called a ‘right to reside’. 

If you have a bankrupt beneficiary, giving them a right to occupy may be the better option. 

A life interest is an asset that can be used to generate income, and as such, if the beneficiary living in the property is forced to declare bankruptcy, there is a possibility that they could be forced to move out of the house and rent it out so that they can use the income to pay creditors.  However, if the beneficiary has a right to occupy only, they cannot be forced out of the home. 

That said, if you have granted a bankrupt beneficiary a life tenancy to occupy a property, be aware this may have unintended consequences for the bankrupt in terms of income contribution assessments.  Even though the bankrupt is not receiving what is traditionally thought of as ‘income’ for income tax purposes, the Bankruptcy Act 1966 (Cth) specifies certain situations – such as the free use of property – may also be deemed as income for the purposes of income assessment.  This may result in the bankrupt being liable to their creditors for the deemed ‘income’ of the life tenancy, even though they are not receiving a specific cash benefit.

For these reasons, the terms of a life tenancy need to be carefully drafted in your Will. 

How we can help

We do not like DIY Wills.  In our view, the transfer of hundreds of thousands if not millions of dollars’ worth of assets should be done properly by someone qualified to advise you and who can draft the necessary documents.  If you are a Will maker and are concerned that a beneficiary to your Will is bankrupt or at risk of becoming insolvent, give our friendly team a call on 1300 654 590 or email us.  If you need further incentive, read this! 

 

The information contained in this post is current at the date of editing – 14 September 2023.

 

1 Section 58(1)(b) of the Bankruptcy Act 1966 (Cth) 

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