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Avoiding wealth transfer pitfalls

Audrey* enjoyed a rewarding life. Her devoted husband, Frank, passed a few years ago – they had built their wealth over a lifetime together and ensured Audrey was financially secure. She has two successful sons and five grandchildren. In her late 80s and in failing health, she could take comfort from the fact her financial affairs had been structured to maximise the benefits for her family for generations to come.

Following Frank’s passing, Audrey’s assets were held across both their longstanding SMSF, and a substantial portfolio held in her name. Audrey understood the importance of having conversations with their sons about her wishes and having them involved in the structuring of her estate in preparation for the transfer of wealth.

While this task was made easier from being a close family unit, it still required lengthy discussions to ensure the best outcome - highlighting the value for all families with wealth to be inherited of having plans in place early to ensure assets pass prudently and equitably.

In dealing with people who have very real hopes and fears, intergenerational wealth transfer is not just about what makes sense through a dispassionate, mathematical lens – it must reflect the clients’ wishes and values around their family and legacy.

This type of forward-thinking planning is crucial, particularly as Australia is in the early throes of the intergenerational wealth transfer, that the Productivity Commission estimates will total about $3.5 trillion by 2050.

Family conversations are critical

Audrey had said that she and Frank, an accountant by profession, always encouraged money discussions with their boys from an early age. In many families, this topic can often be taboo.

But by having these conversations, parents can have greater comfort that their wishes will be respected (remember, wills can be successfully challenged in the court system), and the recipients better understand not only the financial fundamentals, but the gravity of inheriting significant wealth.

It’s critical that it does happen – for two key reasons. Firstly, with former generations, the quantum of wealth shifts wasn’t nearly as pronounced. The baby boomer generation (1946-64) is the first generation where wealth is far more widespread due to property prices and, to a lesser extent, compulsory superannuation. So, the need for these discussions is more important than ever.

Secondly, it’s a reality that basic financial education is sadly lacking in the school system. For those families with a financial adviser, there’s the opportunity include all family members in the discussion. But this is a minority, meaning the onus is on the family to impart this critical skill set on to their children.

Asset allocation needs to be considered

Investment considerations are also a key component. Audrey’s eldest son, John, has a more balanced investment approach, more aligned with his late father’s penchant for fully-franked Australian blue-chip shares, while his sibling Nicholas, five years his junior, has a greater interest in assets with a higher-risk, higher-return investment dynamic.

Although the brothers have differing ideas on investment, they appreciated and understood the foundations of investing courtesy of the many family discussions about financial matters. Part of the wealth transfer process was the appreciation that as assets were passed down, the underlying investments and asset allocation of the capital would inevitably change to reflect the goals and time horizons of the adult sons and their families.

What did this look like in our example? Audrey had a substantial amount in superannuation via her SMSF and a significant personal portfolio. Due to Frank’s conservative outlook, it was overweight large-cap Australian blue-chip shares and cash – given their stage of life, the fully franked dividends came with substantial tax benefits, and investors typically grow fond of holdings that have served them well through the years.

Remember also, markets are volatile. In the 21st century, we have had the Tech Wreck, the GFC, and COVID market meltdowns.

Regardless of life-stage, asset quality within portfolios is paramount in helping clients withstand market volatility and reducing the risk of impairment, as is the need to be diversified across both traditional and alternative asset classes in seeking to produce robust long-term outcomes and generate revenue through the economic cycle. In short, all the capital should not be exposed to all the same risks.

It’s not just about adapting the investment style to each estate recipients’ investment tolerances and prejudices; it is vital to utilise strategies to minimise the tax burden during the transfer.

What happened in Audrey's case

So, conscious her health was rapidly declining, an estate planning lawyer was brought into the fold with Audrey and her sons – seeking to ensure the optimal structure for the impending wealth transfer. What does that look like in practice? Her will was updated to establish a testamentary trust for each son upon her death. Audrey also withdrew her superannuation ahead of her passing to avoid any taxable component being taxed at 15% (plus Medicare levy).

When she passed, the assets were left to her sons in their testamentary trusts (a vehicle that the sons’ entire families could benefit from), and portfolios customised within each trust. Generally, a discretionary (family) trust can be an excellent vehicle for transferring wealth. In addition to the tax-effective flexibility to distribute income and capital gains between beneficiaries, as its ‘lifespan’ is 80 years in most states, by planning the seamless transfer of control (i.e. the pre-determined ownership change of the corporate trustee shares, for example) the portfolio within can endure in the same structure beyond the death of the matriarch or patriarch – in line with their wishes and without needing to sell assets and incur tax.

In Audrey’s case, by adopting this approach, they avoided the real risk that many families confront on the passing of a loved one – no planning, no strategy to minimise the tax drag on the estate, and even no will. Tragically, it often means a time for genuine grief gets consumed by family disagreement over the estate. So much better to plan, especially with $3.5 trillion at stake.

* Family names have been changed

 

Peter Nevill is an Adviser at Viola Private Wealth. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs.

 

30 Comments
John
December 02, 2024

How come no one answered Sandra's question ? It was the first comment !

Sandra
November 21, 2024

What would be a reasonable charge for someone (lawyer, accountant?) To advise me. I don't have a great deal of money to pass on, approx $230,000 plus share which might be worth about the same. My home is worth around $860,000.

Irene
December 12, 2024

Hi Sandra, I am not an expert, but I think you can talk to your accountant first. Are you in any of the industry superfund? If so, you can use their adviser, and if you are a member, the charge is only minimal for one interview. Some superfund even give simple advise for free. Your home will be tax free if it is your principle resident. However, I do not know what is your age, if you already in your 70s like me, you should think of leave some money for yourself if you need carer to come home, or even pay for a good nursing home.

TA Morrison
November 20, 2024

Interesting. No one has said thanks for the Originators to build the fund to pass on to the family. Once passed the benefactors decide how to spend it. Forget the tax issues. It is what makes the world go around!!

john
November 18, 2024

Most of the strategies talked about here sound like a picnic for accountants and lawyers

Alison Marshall
November 18, 2024

There is also the leaving money to a disabled child. I have left my will so that my great nieces and nephews will inherit what is left after my child is looked after by a trust fund. This is to ensure that nobody can take advantage of her.

Phillip Stewart
November 21, 2024

Alison just checking, but are you aware that under the terms of your will you can establish a special disability trust for your daughter under the provisions of Pt 3.18A of the Social Security Act. This type of trust differs from the standard type of testamentary trust in that the child is not disadvantaged when it comes to accessing government financial support. Beyond the scope of this post to go into detail but an experienced lawyer in the estate planning field would be across the specifics.

Peter .c
November 17, 2024

Great conversation everyone.
As my wife and I learnt during the last 5 years losing 4 family members in succession is PLAN PLAN PLAN . If not the tax man and lawyers make a huge profit. We have involved our adult children in financial management for years and it definitely pays dividends financially and emotionally .

Mart
November 15, 2024

"Where there's a will there's a relative"

Graham W
November 16, 2024

And a lawyer or too.

Stephen
November 15, 2024

All very well to transfer assets to a testamentary trust but what happens when one or either son wants/needs to use the capital in the trust for say, a house purchase?

That requires the sale of the underlying assets and a capital withdrawal.

What are the tax and legal consequences then?

tom taylor
November 14, 2024

We completely pulled out everything from super when we were in our late 60's. Why??? Because Mr Morrison when treasurer deemed that people like us had too much money in super. Never mind that for decades we paid the 15% tax that reduces your final sum unlike most overseas super plans that tax you at your marginal rate when you retire. As I explained to my wife if the liberal party was doing this just imagine what the labor party and their industry funds will do to SMSF's. Surprise, surprise there is a bill in the senate to tax unrealised property capital gains with no indexing and no provision if the value goes down to claim a loss.
We invested our money in another business outside of super and pay less tax than when we were in super.
When it comes to our kids they are switched on and there will be very little for the government to expropriate when the will comes up why? Because in our final years we will have distributed all the assets to them. That of course with the quote in mind of be careful you really don't know your family until you share an inherritance.

Dudley
November 15, 2024

"the 15% tax that reduces your final sum unlike most overseas super plans that tax you at your marginal rate when you retire":

Not much difference; in units of annual income:

15% contrib & accum tax; 0% disbursement tax:
= PMT(0%, (85 - 60), FV((1 + (1 - 15%) * 10%) / (1 + 3%) - 1, (60 - 30), (1 - 15%) * -11.5%, 0), 0)
= -$0.2755 (10% capital gain tax rate, -$0.2998)


0% contrib & accum tax; 30% disbursement tax:
= (1 - 30%) * PMT(0%, (85 - 60), FV((1 + (1 - 0%) * 10%) / (1 + 3%) - 1, (60 - 30), (1 - 0%) * -11.5%, 0), 0)
= -$0.2932

Marginal tax rate for SAPTOers taxable income < $32,003 is 0%.
$32,003 / 5% = $640,000

"We invested our money in another business outside of super and pay less tax than when we were in super.":

A number of possibilities therein. One is business has little taxable income, may defer tax by accumulating capital gains.

Dudley
November 15, 2024

Minor error:
", FV(("
should be
", -FV(("
The FutureValue of accumulation (positive) is invested as the PresentValue of disbursement at commencement of disbursement.
Amounts invested in a fund are represented as negative values, amounts withdrawn as positive.

Pete
November 15, 2024

Tom, you left the most relevant “observation” till the last paragraph….
Death brings out the best, and the worst in people !”
There is nothing nastier and more expensive than a will being challenged through the court system !

Dudley
November 14, 2024

"a discretionary (family) trust can be an excellent vehicle for transferring wealth. In addition to the tax-effective flexibility to distribute income and capital gains between beneficiaries, as its ‘lifespan’ is 80 years in most states, by planning the seamless transfer of control (i.e. the pre-determined ownership change of the corporate trustee shares, for example) the portfolio within can endure in the same structure beyond the death of the matriarch or patriarch – in line with their wishes and without needing to sell assets and incur tax.":

Any reason this can not be equally well implemented in a Pty Ltd investment company with beneficiaries being added as shareholders of various class of shares?

straight shooter
November 15, 2024

Interesting question! Dudley, can you please elaborate on "various class of shares"? Thanks!

Dudley
November 15, 2024

"class of shares":

Very common for constitutions of companies to list classes of shares A, B, ..., Y, Z.

Commonly, voting rights of different classes are different, and, dividends paid to different shareholders must be the same for all shares of a particular share class.
Commonly, A-class shares hold all the voting rights, and, other classes have no voting rights. Such A-class shareholders control the distribution of dividends, and, the amount of dividends paid to shareholders of each class of share.
Constitutions of companies can be readily varied and approved by shareholders voting.

OldbutSane
November 15, 2024

A Pty Ltd company is not tax-effective if there are children or grandchildren under 18 as they are taxed at higher marginal tax rates on dividends, whereas income from a testamentary trust is taxed at adult marginal tax rates (special rules that only apply to testamentary trusts).

Dudley
November 15, 2024

"A Pty Ltd company is not tax-effective if there are children or grandchildren under 18":

... not tax effective FOR non-exempted minors ...

'You may be an excepted person if you're a minor and a:
. Full time worker
. Person with a disability
. Person with a double orphan pension'
https://www.ato.gov.au/individuals-and-families/income-deductions-offsets-and-records/income-you-must-declare/your-income-if-you-are-under-18-years-old#ato-Workoutifyoureanexceptedperson

straight shooter
November 15, 2024

Hi Dudley
Many thanks for the information! You are so knowledgeable!!!

Maurie
November 17, 2024

Plus, at some stage, minors attain 18 years of age. At that point, the ATO takes a harder stance in relation to "notional" trust distributions declared in favour of an adult children but who are not the ultimate beneficiary. Whilst a minor, the ATO adopt a more accommodating stance in relation to notional distributions.

Raymond
November 17, 2024

One of the main benefits of a “discretionary” trust (verses a “fixed” trust or a company) is that realised capital gains can be distributed to specific individual beneficiaries ( the discretionary bit) based on their marginal tax rates (the lower the better of course). Individual beneficiaries can then claim the 50% CGT discount to reduce the net tax payable. Companies cannot claim the 50% CGT, so the minimum tax payable by the company from $1 is 25% ( the base company tax rate).

Dudley
November 17, 2024

"realised capital gains can be distributed to specific individual beneficiaries" ... "based on their marginal tax rates":
With various classes of shares, profit can be distributed based on shareholder marginal tax rate.

"Companies cannot claim the 50% CGT, so the minimum tax payable by the company from $1 is 25%":
Capital gains in company are income.
Company tax is credited to shareholder in proportion to dividends.
Shareholder pays tax at their marginal tax rate.
Shareholder can not claim 50% CGT discount originating in company.

Doug
November 17, 2024

The best structure ( in my humble opinion) is a Pty ltd company held within a family trust. The company can pay fully franked dividends as needed and that income can be distributed from the trust at the trustees discretion.
There are extra admin costs but the benefits are the flexibility gained with the structure.

Kym
November 14, 2024

In-specie transfers of assets can occur from super if the payment is as a lump-sum. Only assets in the accumulation phase can be paid as a lump-sum. Pension capital payments must be in the form of cash.
So you have to weigh up the tax disadvantages and advantages of alternative strategies.
If Audrey had some of the super capital in the pension phase, asset sales are taxed at less than the standard 10% CGT a Superfund would usually pay. Depending on the overall asset level in the SMSF will determine the effective tax rate. For example, if there was $5m in the SMSF and $2m of that was in the pension phase, then two-fifths is "tax-free" reducing the CGT tax rate to around 6%.
The downside of this strategy is that only the $3m that is not in pension phase can be paid as a lump-sum. Pension payments are required to be in cash.
If the pension was stopped and the assets converted to cash, all the assets can be in-specie transferred after CGT is deducted at the standard 10% tax rate. So it is a trade-off.
In practice, the $3m is likely to be paid as an in-specie transfer and the capital in the pension phase stays until asset sales occur and then the pension stopped (usually 1 July) and the remaining cash is transferred.

Graeme
November 14, 2024

Hi Peter,
"Audrey also withdrew her superannuation ahead of her passing to avoid any taxable component being taxed at 15%". Does this mean she liquidated shares etc & withdrew cash? Is there an option to withdraw shares?

Rob
November 14, 2024

Yes Shares can be transferred out via an Off Market Transfer - not complicated - have done it. Needs to be at Mkt value - in retirement, no big deal but otherwise could be tax implications

Graham W
November 15, 2024

The shares and other capital based assets can be transferred in specie to a family trust at the SMSF's current value. There is no CGT if the fund is in pension phase. It is best done well before possible end of life. This is what my wife and I are doing. I believe that a family trust is better than a PTY LTD company as it is far easier to include a beneficiary of the trust. Once you make a beneficiary a shareholder of any kind there can be severe Centrelink attribution of asset value. Not so if they are not shown in the Trust Balance Sheet as a beneficiary.

B2
November 17, 2024

See Kym's comment above: In-specie transfers of assets can occur from super if the payment is as a lump-sum. Only assets in the accumulation phase can be paid as a lump-sum. Pension capital payments must be in the form of cash.

 

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