All You Need to Know About Estate Planning
Have you ever wondered how your hard-earned wealth would be inherited should you pass away unexpectedly? It’s true that most of us would rather not be about it, but that also means we are hoping things will work out fine when the inevitable happens. The chances are that it probably won’t work out on its own if you don’t take the proper estate planning steps.
Do you know that despite having a valid will, the transfer of inheritance to your loved ones will not be quick; the bureaucracy of our legal system will take time and may be costly. Moreover, your financial legacy can even be contested in Court by a raft of competing beneficiaries and could potentially be inherited by people outside your bloodline.
And then there are tax consequences to inheritances with hard-earned money at the risk of being pocketed by the taxmen due to poor planning. All debts of the deceased must be paid first before the remaining estate can be inherited.
The problem gets murkier if you were to die intestate, i.e., without having a will. This is especially so if you are a sole trader, a sole director, or a sole trustee of your business of investments.
How does this sound to you?
An already stressful situation can get financially messy for your family if not adequately planned and provided for. You owe it to your loved ones.
The solution lies if you take proactive control of your financial legacy and implement an effective estate plan.
Let us discuss these in detail the following:
o What is Estate Planning?
o The Law of the Deceased Estates: How Wealth is transferred to the next of Kin
o Will vs Estate Planning
o Consequences of Dying without a Will
o Tax Consequences of Death
o How does an Estate Plan Help? Tips and Benefits
What is Estate Planning?
Estate planning is the strategy to ensure that your financial legacy is inherited per your wishes quickly, securely, and with the least amount of tax burden and legal costs. An effective estate plan ensures that your family and loved ones are looked after well, even when you are not around.
Estate Planning strategy is, therefore, about managing your financial legacy smartly for the benefit of your family and the next generations. An effective Estate Plan will have the following components:
(i) Last Will and Testament
(ii) Bloodline Trusts ensure your wealth remains within your bloodline and provides protection in case of divorce and bankruptcy.
(iii) Testamentary Trusts (where needed) are good for saving tax and protecting the inheritance for beneficiaries.
(iv) Enduring Power of Attorney to act on your behalf in case of incapacity.
(v) Shareholder and unit holder agreements.
(vi) Advance Health Directive
(vii) Life Insurance to ensure your mortgages are paid for.
(viii) Superannuation Binding Death Nomination
(ix) SMSF Will, where you have an SMSF
(x) Asset Protection for your family home and other assets in your personal name.
(xi) Tax planning to minimise tax on your estate and the beneficiaries
Nav Accountants and Advisors can help you with comprehensive estate planning services to suit your circumstances. Book a consultation now.
The Law of the Deceased Estates: How wealth is transferred to the next of kin
In Australia, succession and inheritance are governed by State Laws and Court precedents. While the basic procedure of administration of deceased estates in each State is the same, there are some differences in detail. Administering a deceased estate will typically involve the following:
Appointment of Executor or Administrator as Legal Personal Representative (LPR)
Where the deceased left a Will as a last testament, the Executor nominated in the Will assumes the responsibility of administering the estate. Where the deceased died wholly or partly intestate, the Supreme Court of the State will appoint an administrator.
The LPR steps into the shoes of the deceased to wind up their personal and financial affairs, realising the assets, paying the debts, and distributing the estate as per the wishes of the deceased or Intestacy law where there is no will.
Applying for Probate
Probate is the process of the Supreme Court of the State confirming the validity of the Will and the Executor’s authority to deal with the deceased estate.
Before the Executor can apply for Probate, he will need to collate a details list of all assets and dents of the deceased and assure himself that the Will was indeed the last testament. Advice and help will likely be needed with the lawyers at this stage.
Even though the ownership of the estate vests in the Legal Personal Representative immediately upon death, the LPR will, in practice, need to wait for the probate process to obtain the legal title as proof will be required in the form of Probate.
Challenges to the validity of the Will
If a person has doubts about the validity of a Will, such doubts may be raised before the Probate of the Will is granted. The most common grounds for challenging the validity of a will are:
Lack of capacity, i.e. the Will, was made by a person who lacked the legal or mental capacity to comprehend the nature and content of the document. This may be when a person has mental conditions like dementia or is less than 18 years of age.
Undue influence, i.e. the Will was made in circumstances of undue influence or threat of someone.
Fraud, i.e. the Will, has been made but a third party with forged signatures.
The Will also must be executed properly in accordance with the technical requirements of the State in order to be valid.
Family Provisions Claim
While you have the freedom to leave your wealth to anyone you like, Supreme Court has the power under State laws to interfere with this freedom where certain people have not been adequately provided for in the Will.
While the definition of people who can challenge for family maintenance claim differs in each State, generally spouse, children, former spouse, de facto, a person in a close personal relationship or a grandchild or person dependent on the deceased at the time of death may have a right to seek maintenance claim.
74% of the family maintenance claims in Australia are successful. This delays the completion of the administration of the estate and adds to legal costs.
Administrating the assets and paying the debts
Once the Probate is granted, the Executor can go about executing the Will. This may need selling the assets or transferring them in species to the beneficiaries, paying all debts, liabilities, and taxes for the deceased and the deceased estate.
Creditors, ATO, and others who are owed debts by the deceased may also present their claims on the deceased estate.
Lodging tax returns and paying taxes
This Executor will need to lodge the date of death tax return, and deceased estate tax returns and pay all tax liability from the assets of the estate. Any dereliction by the Executor in his obligations towards ATO may make the Executor personally liable for the tax debts of the deceased. Death taxes is another complex area, and you will likely need help from an experienced estate accountant to minimise the tax obligations after death.
Example: Miller vs Taylor [2018] WASC 75
Andre Taylor left his $600,00 to his two children and made his ex-wife the Executor of his State. The apparently small and straightforward estate was contested by Angela Miller, his de facto under the Family Provision Act 1972. The Court awarded Angela Miller $200,000 from the estate even though she had a gambling addiction. The case took a long time, with a legal bill of $502, 227 for both parties (though $159,459 of the legal fee was waived by the lawyers on the displeasure of His Honour).
Angela received one-third of Andre’s estate even though the Will had left nothing to her. Lawyers were the only winners from this.
Will vs Estate Planning
It is a common misconception that if you have made your Will, the job is done, and your financial legacy is taken care of. In fact, a Will and last testament is one of the most basic components of an estate plan.
While a Will is helpful in laying out the deceased’s wishes, yet there is a range of crucial issues that cannot be effectively dealt with by a Will. This can lead to unintended outcomes and add to the time taken and cost incurred in the administration of an estate
A Will cannot deal with assets and interests held thru trusts and companies.
A Will can only deal with assets that are in your personal name, i.e., your family home. However, it is common for Australians to control wealth thru trusts and companies for reasons of tax savings and asset protection.
Even though you may perceive the assets or business held through a structure as your own but the fact is that you control these assets thu an entity instead of owning them outright. The legal ownership remains with the entity and not you personally. Therefore, steps need to be taken to pass control of these entities as per your wishes, and this needs to be done outside your Will.
Wills are not effective for asset protection.
All assets that are in the personal name of the deceased are dealt through a Will and end up in what is called a deceased estate. It is open to all creditors of the deceased and even the ATO to stake their claim against the deceased estate to get their dues settled before the beneficiaries get anything.
Moreover, when a family member is facing bankruptcy situation, any wealth he inherits from the deceased estate is at risk of being applied toward his bankruptcy. Therefore, Wills are not very effective in protecting your inheritance either in the deceased estate or in the hands of the final beneficiary.
Wills cannot deal with incapacity
Will can only deal with the consequences of death. Where a person is still alive but has lost the legal capacity to make decisions due to a mental health issue like dementia, accident, trauma or another serious health issue, a Will is of no use. Any assets or bank balances owned by the person cannot be dealt with. More than a Will, an Enduring Power of Attorney and an Advance Health Directive are very useful in such circumstances.
Wills are open to disputes
You may be surprised to know that nearly 50% of the Wills in Australia are disputed. This can result in unexpected outcomes, with your wealth being inherited by people against your wishes. The main grounds for challenging a Will are discussed below.
Family Maintenance Disputes
A Will can be disputed by a range of aggrieved people who are entitled to lodge a Family Maintenance Claim. Even where a person dies without leaving behind A Will, intestacy laws allow all eligible persons to dispute a will and lodge a claim on the deceased estate. This adds to the delays and costs of administering the estate.
Capacity Disputes
Testamentary capacity is essential for a Will to be valid. Where the person has Alzheimer, Parkinson or another disease which can impair their judgment, it can be a valid ground for disputing a Will. It is a good idea to obtain a testamentary capacity certificate from a Geriatrician or another medical specialist.
Undue Influence
Wills can often be challenged on the grounds that the judgment of the deceased was not independent and was instead influenced by someone close. Undue influence usually involves the exploitation of a relationship of influence by convincing a Will maker to favour that person to the detriment of others. It occurs most often when a person is vulnerable and dependent on others, such as when a person is elderly or ill.
Wills cannot deal with Superannuation.
The deceased’s superannuation benefits do not automatically form a part of their estate. In other words, the deceased’s Will cannot dictate how their superannuation benefit should be distributed to their loved ones. Generally, the superannuation is paid directly to the beneficiaries based on the Binding Death Benefit Nomination (BDBN) lodged with the fund. If there is no BDBN or inadequate documentation, the Trustees of the super fund may use their discretion as per the fund’s rules to distribute the benefit either to the deceased’s estate or their dependents.
Wills cannot deal with Life insurance
Distribution of proceeds of any life insurance policy is governed by the terms of the policy rather than the Will. Most life insurance policies allow you to nominate a beneficiary(s) who should receive the insurance payout. Where no beneficiary is designated, the payout can be made to the deceased estate.
Will does not effectively deal with assets in a structure like Trust or Companies
A Will only deals with the assets that are in your personal name. However, it is common for Australians to own assets in family entities like a trust or a company. Such assets that are held thru entities do not form part of the deceased estate regardless of the control you exercised over the entity and, therefore, cannot be effectively dealt with via a Will.
As you can see, any of the above scenarios lead to very costly and unintended outcomes, which can be prevented by having a well thought estate plan.
Consequences of Dying without a Will
When someone dies without a will, they are said to have died “intestate”. As there is no will, the State’s intestacy laws take over. Even where there is a Will, a partial intestacy may still occur if the Will does not dispose of all the assets.
This generally happens when the Will is not updated or reviewed periodically.
The Court will appoint the Administrator
An application for a grant of letters of administration on intestacy needs to be made to the Supreme Court, usually by an eligible beneficiary. The Administrator will then set about the process of collating all the assets and liabilities of the deceased and paying all the debts and taxes. This can be messy as information may not be readily available, and there may be many loose ends.
You will not be able to choose who gets your wealth in case of intestacy
Without the benefit of an insight into your testamentary wishes in case of intestacy, your estate will be distributed by a set distribution formula prescribed in your home state’s succession legislation. Intestacy legislation can differ from State to State but will generally seek to distribute assets amongst relatives using a pre-defined formula as to who benefits from the estate and in what proportion and priority.
Therefore, the biggest issue with dying without a will is that your hard-earned wealth may not be distributed to the ones you love most, at least not in its entirety. In fact, your financial legacy may even be shared by people outside your bloodline and people not close to you at all.
Worst still, where the family home is not jointly owned by the spouses, the surviving spouse may lose the ownership of the family home. The risk increases with blended families and second marriages.
Unintended distribution of personal chattels and heirlooms
As the intestacy formula is very inflexible; therefore, family possessions of sentimental value may go to unintended heirs. This can create disputes in the family and can, delay the settlement of the estate and increase legal costs.
Potentially higher taxes for the beneficiaries
Unintended inheritance to the beneficiaries may also create increased tax liability in the hands of the recipients, and they will not be able to stream the income to family members on a lower marginal tax rate.
Providing for minor children and family members with special needs relatives
Wills are a good instrument to provide for the welfare of your loved ones long after you are gone. Not having a will created uncertainty and your inheritance could go to unintended recipients. This can also lead to family provision claim challenges to the estate resulting in delays and legal costs.
Example:
Sam and Tim were married for seven years but are now separated for the past three years, but divorce proceedings have not commenced. Tim has two adult children from a previous marriage. Sam had no children of his own.
If Tim dies without leaving a will, his separated wife Sam is likely to get 60% of his estate, leaving only 20% each for these two biological children. Tim will have no control over his legacy as the set formula for estate distribution in his home state will dictate the distribution of his wealth.
If Tim’s children feel aggrieved, they can lodge a family maintenance claim which will make the proceedings even messier, more costly, and time-consuming.
Tax Consequences of Death
While there is no direct nexus between death and taxes in Australia, bequeathing wealth to non-residents and tax-advantaged entities may result in tax obligations on your deceased estate.
Beneficiaries do not pay tax on inheritance, but the tax regime will eventually catch up when they put the inheritance to generate income or eventually sell the inherited assets. And then there are other tax and reporting obligations on deceased estates.
All these can be complex and need carefully crafted tax strategies to minimise the tax obligations of the deceased estate and any future tax obligations for the beneficiaries.
Date of death tax return
The date of death tax return is the final income tax return of the deceased from July 1 of the financial year of death up until the date of death. The Executor must not only lodge the final tax return of the deceased but also needs to update any outstanding tax returns of the previous years. Any tax liability accruing will need to be paid from the deceased estate, and likewise, any refund will also be made to the deceased estate.
Deceased estate tax returns
The Executor of the estate must lodge a tax return of the deceased estate for:
– the period from the date of death to the end of the financial year; and
– for each subsequent year until the estate is fully administered and no longer earning any income.
The deceased estate tax return should include all amounts that would have been assessable to the deceased if alive but received after death and other income earned by the deceased estate in its own right.
Capital gains tax consequences of death
While any unrealised capital gains on death are generally rolled over until the asset is eventually sold, bequeathing any assets to tax-advantaged entities like a charity or a non-resident may result in taxable capital gain even if unrealised. Further, the tax-free status of the principal residence could be lost if care is not taken to adhere to the special tax provisions for inheriting the property.
Read our blog here on “how to save capital gains on inherited property”.
Death and small business capital gains concessions
A small business taxpayer is entitled to significant tax concessions on capital gains of the business where specific eligibility criteria are met. Importantly, these small business capital gains concessions could be available to the people inheriting the deceased’s estate where:
– the deceased himself would have been eligible for these concessions just before death; and
– the actual capital gains accrue within two years of the individual’s death, though ATO has the discretion to allow for a longer time frame.
GST issues on death
Broadly speaking, the death of a person may result in GST consequences where:
– the deceased was personally registered for gst (e.g. as a sole trader)
– where a partner of the partnership firm that is registered for gst dies.
Where the sole trader registered for gst dies, his legal personal representative must apply to ATO within 21 days for cancellation of registration. Where the Executor of the deceased is empowered under the Will to carry on the enterprise, the Executor must get registered for gst.
Similarly, where a partnership may be dissolved or reconstituted as a result of the death of a partner, the GST registration of the partnership will need to be cancelled, and the reconstituted partnership will have to obtain new GST registration.
The Executor of the deceased will be responsible for lodging the final BAS return, updating all outstanding BAS returns and paying the BAS debts from the deceased estate.
Impact of death on partnership
Under general law, a partnership is dissolved in a new partner is admitted or an existing partner retires or dies and has to be reconstituted. Where this occurs, the new partnership will have to obtain a new Tax file number, a new ABN, and a new GST registration. Also, both the old partnership and the reconstituted partnership will have to lodge their own Partnership Tax Returns
However, ATO acknowledges that where the death of a partner only results in a “ technical dissolution”, the partnership may be able to carry on without the need for a new TFN, ABN and new GST registration.
A partnership will need to plan and take proactive steps in order to result in only a “technical reconstitution” on the death, retirement or admission of a new partner. Feel free to book a Free 1Hr Consult with us if you need some help.
Death of a shareholder or director who owes money to the company for loans taken
Where a shareholder or director has borrowed money from the company, such borrowing is at risk of being taxed at the penalty rate of 47% if :
– the loan is not repaid before the due date of lodgement of return (or the actual date of lodgement if lodged earlier than the due date); or
– a complying loan agreement is not entered into before the last date of repayment.
This is an integrity measure imposed by Division 7A of the Income Tax Act 1936.
Where a shareholder dies with an outstanding loan balance, care must be taken to avoid the loan being taxed by ATO as deemed a dividend in the hands of the Executor of the estate.
This is a complex area, and consider seeking professional advice.
Executor’s personal liability for tax debts
An executor has an important role to play and can be held personally liable for the debts of the deceased in certain situations. For example, where the executor has notice of the tax debts of the deceased but still proceeds to distribute the assets without paying the tax debts first, the ATO can make the executor personally liable for the deceased’s taxes.
Tips and Benefits of How an Estate Plan Help
In the absence of an effective estate plan, your family may have to wait months and sometimes years to inherit your wealth, and children and vulnerable family members may not be adequately provided for; worst even, your wealth may even be inherited outside your bloodline and close family.
An effective estate plan helps you avoid unintended outcomes and has many benefits, some of them discussed below:
Protecting assets in divorce and retaining them in your bloodline
Where the inheritance is received by your children or spouse in their own name, it will generally form part of their personal assets and be part of the matrimonial property open to divorce proceedings. Therefore, if your spouse or children were to marry, the inherited assets would be available for being carved up in a divorce settlement.
Therefore, your financial legacy could, at some point, be at risk of going to people outside your bloodline and with no degree of closeness to you.
A good estate plan can prevent this through the effective use of testamentary trusts and bloodline trusts.
Protecting from risks of bankruptcy
All debts your debts, taxes, and mortgages have to be paid from the deceased estate before the net proceeds can be distributed. Having adequate life insurance can ensure that your debts will be taken care of.
Also, your children or spouse inheriting your assets can also lose them to their own bankruptcy if they are passing thru rough financial weather. This can be avoided by passing them the inheritance via trust structures rather than in their own names.
Smooth business handover
When you run a business in partnership or own properties in a unit trust with other partners, it is a good idea to have a unit holder or shareholder agreement in place. This will ensure that everyone knows and is comfortable with each other’s succession plans. This will avoid surprised and disputes among partners and business associates.
When you run a business via a structure like trust, you can easily pass on the baton to your next generation by appointing a successor director or successor appointor. This will prevent your inheritance from going through the probate process and eliminate disputes.
Minimise disputes and litigation
When you own assets in your own name, they end up in the deceased estate thru Will or intestacy. Deceased estates are open to litigation, and family maintenance claims and debts need to be settled as well. However, assets owned thru trusts and company structures do not have to pass thru deceased estates.
A good estate planning strategy circumvents this by having most of the valuable assets passed as per your wishes via structures and entities. This not only avoids the legal bureaucracy of deceased estates, but the control is also passed on quickly.
Minimising the taxes
While the transfer of assets due to death does not in itself result in tax, beneficiaries eventually pay tax when they encash their inheritance. A good estate plan takes tax outcomes into account both at the time of death and in the future and delivers a strategy to minimise the taxes.
Caring for relatives with special needs
When you have a child or a relative with special needs that need to be provided for, it can be done thru testamentary trusts or special disability trusts.
Dealing with incapacity
A will deals with the administration of your assets after death. What if you suffer legal incapacity due to conditions like dementia or an accident trauma? You may still need to make decisions about day-to-day legal, financial, and medical matters
A Will cannot deal with such situations, and you will need to go thru a lengthy, stressful, and costly process of applying to courts for an Administrator or a Guardian to act on your behalf.
Need Help in Estate Planning?
Estate planning is a meticulous step all of us need to do to ensure that our hard-earned wealth is handed down to our next kin as we desire.
At Nav Accountants, we take this vital step seriously.
Contact us to discuss how you can begin putting your estate plans into place.
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