Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 269

Most estate planning for tax is inadequate

Over the next 20 years, there will be an intergenerational transfer of wealth the likes of which has never been seen before. Wealthy baby boomer parents will die leaving their estates, in most cases, to their children. Most will also leave income tax liabilities.

When they receive their inheritance, the children will have two main tax issues to deal with:

  • Minimising tax payable on the benefit (eg. tax payable by the estate) and
  • Finding an investment structure to hold assets that allows for future tax minimisation.

Through proper management and planning, the 'after-tax' value of the inheritance can be greatly improved. Despite this, many wealthy individuals have a will that does not deal with the tax consequences of their death adequately.

What can be done within a will?

A will provides excellent opportunities for tax planning. Generally, under a will, assets can be transferred to a new investment structure without the usual impost of stamp duty or capital gains tax. The ownership of assets can be rearranged to provide a better tax result.

A will also allows for the establishment of a 'testamentary trust'. In broad terms, assets can be inherited by a beneficiary but held via a trust which they control. The beneficiary can generally then direct income from the trust to pay various family members in a tax-effective way. Family members receiving distributions may include children under the age of 18. Family trusts, set up while a person is alive, cannot distribute to children under 18 without the beneficiary being taxed at the top marginal tax rate.

Management of tax payable by the estate

In most cases, the assets of the deceased are liquidated and the funds distributed to the various beneficiaries. This can result in two major tax consequences:

  • Capital gains tax on the disposal of the deceased's assets
  • Death benefit tax on superannuation withdrawals.

Proper planning may reduce or eliminate these taxes.

1. Capital gains tax

In basic terms, a testamentary trust can provide flexibility to those who receive taxable income resulting from the sale of estate assets.

I recently had a client die while holding two properties. One was his home, which is exempt from capital gains tax. The other was a 'weekender' which had grown in value by $400,000 since it was purchased. He had four children, who each had personal taxable income over $100,000, and 12 grandchildren, all under 18-years-old.

Before the property was sold, it was transferred, under the will, to four testamentary trusts, one for each beneficiary. This allowed for the capital gain to be split between the grandchildren. As a result, no tax was paid.

2. Superannuation death benefit tax

A common scenario is where the last parent dies and leaves superannuation to their adult, non-dependant, children.

Adult non-dependant children will be required to withdraw money from superannuation. They have no choice. This will usually result in tax of 17% being payable on the withdrawal of the 'taxed' portion of superannuation. If the member's balance is large, this can amount to many hundreds of thousands of dollars in tax.

So, what can be done?

The simplest way to avoid death benefits tax is for the superannuation to be withdrawn before death. The assets are then held in the member’s personal name instead of being held in the superannuation fund. A withdrawal by a member, over 65, and in some cases earlier, is not subject to tax.

The obvious problem with this strategy is we don’t know when we are going to die. However, often we have some idea, and if reducing income tax payable is important to the member, then steps can be taken.

In a simple scenario, a member with a terminal illness can withdraw their superannuation themselves. However, individuals are often not able to make such decisions once their health has deteriorated. An alternative is for a power of attorney to be provided with the authority to make the withdrawal. In my experience using an attorney can work, but only if the following takes place:

  • The member gives clear instructions to the power of attorney before their health deteriorates, and
  • The process is explained to the other family members.

It always needs to be remembered that the attorney owes a fiduciary duty to act in the best interest of the member.

There are a number of strategies that can be used to make a speedy withdrawal, but these are outside the scope of this article. Suffice to say that, where the tax liability is reasonably high, it may be worth considering as part of a tax effective estate plan.

Strategies to minimise future income tax payable by beneficiaries

In recent years, it has become increasingly difficult to invest in a tax-effective way. Changes to superannuation place limits on the ability to reduce income tax. Labor policy includes additional measures such as the removal of negative gearing and the taxing of trusts at a rate of 30%.

There is every likelihood that future beneficiaries may receive an inheritance in an environment where:

  • Family trusts no longer provide a viable tax planning strategy
  • After-tax superannuation contributions are limited to $100,000 per year or less
  • A person can no longer make after-tax superannuation contributions once their balance reaches $1,600,000.

Two strategies could be considered:

1. Holding investments long term via a testamentary trust

For many years, families have used discretionary trusts (also known as family trusts) to hold investments and distribute income to family members with little or no taxable income. Labor intends to stop this. Their proposed policy can be found in a fact sheet titled “A Fairer Tax System – Discretionary Trust Reform”. On page 10, it states that the policy will not apply to testamentary trusts. If legislation is eventually introduced, and this exemption remains, testamentary trusts may become a useful structure for holding investments for the long term.

2. Lending to adult children so they can make contributions

I expect the following scenario becoming common in the future:

  • Children not having available funds to make superannuation contributions during their working life
  • When they are older, perhaps in their 60’s, receiving a sizable inheritance
  • Only being able to transfer a small portion to superannuation due to contribution restrictions.

In selected circumstances, the following strategy may be useful:

  • Parents lend money to their adult children
  • The children make a contribution to superannuation
  • The loan is 'paid back' out of the estate on the death of the parents.

If implemented correctly, this strategy may result in additional funds ending up in the beneficiaries superannuation accounts. However, there is a lot to consider before implementing a strategy like this and professional advice should be sought.

Conclusion

The purpose of this article is not to provide an exhaustive list of potential strategies or to analyse any particular strategy in depth. Instead it is to alert readers that there are opportunities available and to encourage you to seek advice sooner rather than later. I have found that many people are uncomfortable speaking about estate and death issues. I understand this. However, a well thought out and considered estate plan can not only result in significant tax savings but also provide for greater family harmony.

 

Matthew Collins is a Director of Keystone Advice Pty Ltd and specialises in providing superannuation tax, estate tax and structural advice to high net wealth individuals and their families. This article is general information and does not consider the circumstances of any individual investor. It is based on a current understanding of related legislation which may change in future.

5 Comments
Steve
September 05, 2018

Thanks Matthew.

As a trustee for a testamentary trust, I laud your comments. Personally, as an investment vehicle, I find them more flexible than a SMSF (and super funds in general). However, the dividend imputation changes proposed by the ALP will take some of the shine off its tax effectiveness, just like the SMSFs. But you don't hear the same level of outcry from trustees of TTs as you do from trustees of SMSFs.

Warren Graham
September 02, 2018

A very complicated issue on which your article has shed a bright light.

Has caused me to rethink and I am sure will enlighten others.

Thanks

Warren

Steve Christie
August 31, 2018

Great article Matt! One of the challenges can be to get people to deal with death and start some of these discussions. However, so important.
Kind regards
Steve

Matthew Collins
August 31, 2018

Thanks for the feedback Steven. I am going to make a brief comment about your situation. Note my comment is of a general nature and is not advice. However, if it is of interest, you may want to mention it to your accountant / adviser and get some advice on the issue.

You have done a good thing by implementing a recontribution strategies. My only concern is the big difference between your balances. Perhaps this can't be changed (eg. you have met contribution limits / too old to contribute etc). Also under current law, having a balance under $1.6 million results in pensions being tax free etc.

The big unknown is - will there be future legislation that results in you paying income tax on your pension? No body can predict the future, however, there is an argument for spouses, where possible, to have equal balances. Labor had a policy where they where only the first $75,000 of income received on a pension will be tax free. If this policy is ever introduced then equal balances would be very valuable.

Steven T.
August 31, 2018

Hi Mathew

Excellent information and advice on tax minimization strategies for families.
My wife and I are in our 60's and belong to a Industry Superannuation Fund.
Using a recontribution strategy and the bring forward rule within our fund we have achieved the following outcome
Wife's taxable component 2015 - 54%, now 2.57%, balance 150k.
My taxable component 2013 - 62%, now 23%, balance 1.25m.
For your information only.

Kind Regards

 

Leave a Comment:

     

RELATED ARTICLES

The impact of super changes on estate plans

Does your will treat your super fairly?

Thou shalt not covet … thy neighbour’s house

banner

Most viewed in recent weeks

Lessons when a fund manager of the year is down 25%

Every successful fund manager suffers periods of underperformance, and investors who jump from fund to fund chasing results are likely to do badly. Selecting a manager is a long-term decision but what else?

2022 election survey results: disillusion and disappointment

In almost 1,000 responses, our readers differ in voting intentions versus polling of the general population, but they have little doubt who will win and there is widespread disappointment with our politics.

Now you can earn 5% on bonds but stay with quality

Conservative investors who want the greater capital security of bonds can now lock in 5% but they should stay at the higher end of credit quality. Rises in rates and defaults mean it's not as easy as it looks.

30 ETFs in one ecosystem but is there a favourite?

In the last decade, ETFs have become a mainstay of many portfolios, with broad market access to most asset types, as well as a wide array of sectors and themes. Is there a favourite of a CEO who oversees 30 funds?

Betting markets as election predictors

Believe it or not, betting agencies are in the business of making money, not predicting outcomes. Is there anything we can learn from the current odds on the election results?

Meg on SMSFs – More on future-proofing your fund

Single-member SMSFs face challenges where the eventual beneficiaries (or support team in the event of incapacity) will be the member’s adult children. Even worse, what happens if one or more of the children live overseas?

Latest Updates

Superannuation

'It’s your money' schemes transfer super from young to old

Policy proposals allow young people to access their super for a home bought from older people who put the money back into super. It helps some first buyers into a home earlier but it may push up prices.

Investment strategies

Rising recession risk and what it means for your portfolio

In this environment, safe-haven assets like Government bonds act as a diversifier given the uncorrelated nature to equities during periods of risk-off, while offering a yield above term deposit rates.

Investment strategies

‘Multidiscipline’: the secret of Bezos' and Buffett’s wild success

A key attribute of great investors is the ability to abstract away the specifics of a particular domain, leaving only the important underlying principles upon which great investments can be made.

Superannuation

Keep mandatory super pension drawdowns halved

The Transfer Balance Cap limits the tax concessions available in super pension funds, removing the need for large, compulsory drawdowns. Plus there are no requirements to draw money out of an accumulation fund.

Shares

Confession season is upon us: What’s next for equity markets

Companies tend to pre-position weak results ahead of 30 June, leading to earnings downgrades. The next two months will be critical for investors as a shift from ‘great expectations’ to ‘clear explanations’ gets underway.

Economy

Australia, the Lucky Country again?

We may have been extremely unlucky with the unforgiving weather plaguing the East Coast of Australia this year. However, on the economic front we are by many measures in a strong position relative to the rest of the world.

Exchange traded products

LIC discounts widening with the market sell-off

Discounts on LICs and LITs vary with market conditions, and many prominent managers have seen the value of their assets fall as well as discount widen. There may be opportunities for gains if discounts narrow.

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.