Wealth transfer: how to beat tax traps

Sep 19, 2020

Tax-efficient estate planning can help align the best interests of the will-maker and beneficiary by avoiding tax traps and ensuring assets are distributed fairly across different generations of family and friends. But only 55 per cent of Australians are believed to have written a will and even fewer have developed a comprehensive estate plan, says tax expert Adrian Raftery.

"From a personal loved ones' perspective – let alone a tax one – I find this absolutely staggering," Raftery says.

In Australia, life expectancy has increased over recent decades and is about 81 years for males and 85 for females, which might encourage people in their sixties and seventies to put off making a will. But the death toll from this year's bushfires and COVID-19 pandemic – though small compared with the US or Europe – is a reminder that the only certainty about death is that it will happen.

"We live in a death-avoiding culture," says Chris Hall, chief executive of the Australian Centre for Grief and Bereavement, which offers grief and bereavement education.

"It is very difficult for people to consider their impending death," he says, which means many important estate-planning issues are forgotten or ignored until it is too late.

Hall says the financial and emotional trials of grieving friends and family often start long before a death.

"People often give up their work to look after the dying, which can become a full-time job and financial burden with a significant financial impact," says Hall, who estimates that on average each death leaves five bereaved people.

Raftery says the biggest estate-planning mistake is failing to write a will, or not updating an earlier will to take account of major life moves such as remarrying or big changes to personal wealth.

Other costly errors include not taking into account your beneficiariesmarginal tax rates (which can result in the inequitable distribution of an estate if some of your heirs are pushed into higher tax rates) and forgetting that superannuation needs special consideration because it is not an estate asset that automatically flows to the estate.

The first step in getting it right is to have a valid, up-to-date will to avoid "dying intestate", which means the courts decide who gets your assets and might not take account of your wishes or situation, according to Victoria Legal Aid.

Leading tax advisers say targeting the family home, other assets and superannuation are the key next steps.

Family home

There is no capital gains tax liability on a deceased person's family home provided the property is sold by the estate or beneficiary within two years of the date of death, according to Mark Chapman, director of tax communications at H&R Block.

A spouse, or beneficiary of the will, can continue living in the home indefinitely without triggering any CGT liability, Chapman says.

The main residence exemption applies even if the deceased was not living in the home at the time of death, which might arise if they moved into a care home for their final years, he says. The property can continue to qualify for the exemption up to six years after moving out, if the house is rented, and indefinitely if it is empty.

Other assets

Raftery says will-makers and their advisers should assess opportunities to ensure tax authorities don't take a big bite out of the estate or create new liabilities for beneficiaries.

For example, problems can arise if one half of an estate, which is tax-free cash, is left to a beneficiary on a low income, and the other half, which is a large share portfolio with unrealised capital gains tax, is left to another on the highest marginal tax rate.

"This means there can be significant CGT liabilities, which might cause disputes," says Chris Balalovski, a partner with BDO, an international tax consultancy.

Paul Moran, a tax specialist, financial adviser and principal of Moran Partners Financial Planning, says: "Realised capital losses die with the deceased, but unrealised capital gains are inherited by the estate."

That means any CGT liability has to be met from the deceased's estate before distributing what is left for beneficiaries.

A better option, says Balalovski, is to plan the will so that shares go to beneficiaries on lower taxable incomes, which can ensure future income and prevent assets being sold to pay a tax bill (if dividend payouts and so on push the beneficiary into a higher tax bracket).

Alternatively, if an estate is substantial and there are children under 18 who are potential beneficiaries, consider a testamentary trust, which is created by a will to provide a greater level of control over the distribution of assets to beneficiaries.

The trust receives and invests the inheritance for the benefit of current – and future – beneficiaries, creates a way of managing family wealth after death and allows for distributions that target a beneficiary's most effective tax rate.

"While you might not be around to oversee the management of the trust itself, you will have some comfort knowing your loved ones will be looked after financially and not savaged by the Australian Tax Office," says Raftery.

Superannuation

With more than $3 trillion in superannuation assets, retirement savings are an increasingly important component of estate planning, says Raftery.

"Superannuation is not an estate asset, which means on death it does not automatically flow to the estate of the deceased," he says. The danger is that unless you've specified otherwise, the fund trustee will decide who gets what according to the rules of the fund.

Lump-sum payments to dependants, such as a spouse or children under 18 (or those under 25 and living and studying at home), are tax-free. But payments to non-dependants, which includes adult children, can be taxed at 17 per cent. Payments from insurance policies linked to the super fund can be taxed at 32 per cent.

"A simple mistake could send tens of thousands of dollars to the taxman," Raftery says.

Anna Hacker, national manager of estate planning with Australian Unity Trustees, say mistakes can be avoided by ensuring your executor structures payment of benefits to take account of the tax status of the beneficiary.

Hacker urges will-makers to check the trust deed of their superannuation fund, particularly for self-managed super funds, to make sure binding death benefit nominations comply with the rules.

"Even a small technical error can void any nominations and result in the wrong people receiving an inheritance," she says.

A binding death nomination is valid for three years from the date it is signed, or non-lapsing depending on the superannuation trust deed options. It can be renewed, changed, updated or revoked at any time.

"This is important because the tax-free status of a child beneficiary changes when they go from a minor to an adult," says Raftery.

Hacker says: "There have been recent cases where a person nominated their 'trustee' of their estate rather than the 'legal personal representative' as required by the trust deed and the death benefit nomination was deemed invalid, meaning the trustee can then make their own decisions about where your death benefit goes.

"Get the right people into the right administrative and financial roles."

For example, a financial attorney, who is someone given full authority to deal with legal and financial affairs if you are incapacitated, has a lot of power if you become unable to make decisions.

"Ensure the person in that role makes decisions that benefit you only and not potentially themselves," Hacker says. "Potential abuse is a big and growing issue, particularly with blended families.

"As an attorney, they may be able to sign a binding death benefit on your behalf, so you need to make sure you are clear as to whether you wish them to have this power."

Not making this clear could mean your superannuation goes to someone you do not wish to benefit.

Another problem is when an attorney chooses not to sign a renewal of a binding death benefit nomination.

"This is particularly critical for blended families where each party may have completely different intentions and their control of the superannuation may result in the intended party not benefiting at all," says Hacker.

Original article published in The Australian Financial Review here on 19 September 2020.

 

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