Getting started with estate planning

Getting started with estate planning

It may be hard to think about life after death but there's no time like the present.

Although the terms “succession planning” and “estate planning” are sometimes interchanged, in fact they are two complementary yet distinct aspects of managing what happens to an individual or a business when its principal has moved on.

“Succession planning,” says Ray Cummings of the Melbourne-based tax firm Greenoak Advisory, “deals with assets whilst you are still alive. Estate planning deals with your assets after you have died.”

It’s not uncommon for individuals and business owners to put off estate planning. People often procrastinate when it comes to contemplating their own death.

And all too often, says Cummings, people “do not know where to start, think it’s too complicated, or are simply afraid of going anywhere near lawyers. Sometimes you can nag and nag but more commonly people are spurred into action following the death or serious illness of someone close to them or their own serious illness or near-death experience.”

The estate planning process: getting started

At a simple level, if all you have is a principal residence and other assets held jointly with a spouse, there may not even be any need for a will. At the other end of the spectrum there may be personally held assets, controlled entities, superannuation funds and insurance policies. In such cases, things are obviously more complex.

Either way, the end of the financial year is a good time to take stock of your individual needs and make a plan.

“I follow a process — nothing exotic but it does give some format,” says Cummings, who shares his formula below:

•    Information gathering: Find out who owns what – basically to separate the personal assets from the non-personal.
•    Decision-making: Decide who gets what.
•    Valuation: Sometimes it is necessary to put a value on assets as people want to ensure assets are equally divided, particularly where different items of property are to pass to different parties.
•    Implementation: Draft wills and other legal documents.

“It is obviously advisable to have some type of formal estate planning document setting out who is to get what, the valuation of assets, formal legal documents and the like,” explains Cummings.

“It’s also useful for there to be some type of document explaining why particular beneficiaries have received certain assets. This can perhaps save arguments or at least help beneficiaries understand your decisions after you have gone.

“The other important part of the process is to remember that the estate plan is not ‘set and forget’. There will be changes in family and personal circumstances, asset holdings and the like, and these may require revision or a complete rewrite of the estate plan.

“The most important thing is to at least start the process and not get bogged down.”

Trusts in estate planning

“I find over and over again that even sophisticated business people think all they need to do is have a will drafted and all their assets will be take care of,” says Cummings.

“But if you take the position of assets held by a family trust, clearly these are not owned by the individual; the trust continues after their death. The assets of the trust are not dealt with by the will so it is important to deal separately with assets owned by controlled entities such as trusts and superannuation funds.”

If, for example, you have assets owned in a family trust, according to Cummings you can leave what is referred to as a Letter of Wishes for any subsequent trustee, which sets out how you wish the income and capital of the trust to be dealt with after your death.

The problem, according to Cummings, is that this is not binding and has absolutely no legal effect.

Alternatively, you can make provision within the trust deed as to certain critical powers and who should control the trust on your death. The position of Appointor to the trust is critical, as this is the person or persons who will essentially control the trust on your death, as they have the power to appoint and remove the trustee.

The position of Guardian is also important, as he or she is the one who needs to consent to the exercise of various powers by the trustee.

Testamentary trusts: what are they?

“At a simple level,” says Cummings, testamentary trusts are “trusts created by someone’s will that come into existence on their death.

“The advantages are that normal adult tax rates apply to minors deriving income from testamentary trusts. They also represent a method to leave assets for the benefit of ‘at risk’ beneficiaries such as business people who do not want to hold assets in their own names.”

Superannuation death benefits

Superannuation is a complex, specialised area and it’s often advisable to consult with a specialist. There are issues around the binding death benefit nominations and treatment of amount paid out on death, dependent on whether the recipient is a tax dependent or a non-dependent.

Tax returns for the deceased and the estate

A tax return must be lodged on behalf of the deceased person for the period from 1 July through the date of his or her death. The first estate tax return then covers the period from the date of death up to 30 June of that financial year.

According to Cummings, the estate can broadly be treated as a separate taxpayer, with normal marginal tax rates applying for a period of up to three years or until it is fully administered. After that point in time, income in the estate will be taxed at the top marginal personal rate.

Capital gains tax and estate planning

There is a popular misconception that the capital gains tax (CGT) operates as a “death tax”.

“The CGT does not operate as a death tax,” Cummings assures. “For pre-CGT assets, the estate or beneficiaries are considered to have acquired the deceased's assets for their market value at the date of death. They only pay tax to the extent that those assets increase in value and are subsequently sold.

“As an example, if a person had a pre-CGT asset and it was worth A$1 million at the date of their death, their legal personal representative has a cost base for the asset of A$1 million and will only pay tax when they sell the asset and only on the amount over A$1 million.”

For post-CGT assets, no tax arises as a consequence of death. Beneficiaries inherit the deceased's cost base and pay no tax until the assets are sold.

For example, says Cummings, “if the asset cost A$1 million and may have been worth A$1.5 million at the date of death, the beneficiaries inherit the A$1 million cost base. If they then sell the asset for A$1.5 million, tax would be payable on A$500,000.”

Principal residence and CGT

According to Cummings, the issue of a person’s principal residence is usually straightforward: it passes to a spouse or other family member who continues to occupy it as their principal residence and so the CGT exemption is maintained.

In other cases, however, things can get quite complicated.

“If a house is not occupied as someone’s residence,” explains Cummings, “the broad rule is that there is a two-year period in which to sell the dwelling following someone's death and any gain will be CGT exempt. In other situations there are rules which prorate the gain into a taxable and exempt component subject, dependent on the use of the property at various points in time.”