A Meaningful Financial Plan Includes a Meaningful Estate Plan

They say there are two things you can’t avoid: death and taxes. Estate taxes, commonly referred to as "death duties," were abolished in 1980. However, in 1985 the Federal Government introduced capital gains tax (CGT). This now earns the government more money on deceased estates than death duties ever did. Capital gains tax and stamp duty also sometimes applies to your family home when you die.

A testamentary trust is an effective weapon to put in your will to dampen the effects of CGT and Stamp Duty. A testamentary trust is like a family trust that is established by a last will and testament. It is simply a trust put in your will to give your beneficiaries flexibility in dealing with your gifts to them.

When CGT was introduced in 1985 the family home was made exempt yet within one generation every family home will be liable for tax when it passes through the estate. Often there are unintended consequences in leaving bequests to your loved ones and much avoidable tax is often paid because of poor estate planning.

As an example, a husband with a property on the coast where he intended to retire dies prematurely. If he leaves everything in his will to his wife, he may unknowingly have caused unintended hardship for his surviving spouse. Let’s say she decides the property is stopping her from receiving the aged pension – or just prefers to live in their existing home – and gives the property to her children.

The children are initially happy with the gift but the property has increased in value and when it is transferred into their name they will receive a stamp duty bill of thousands of dollars. The problem becomes even worse when their mother gets a notice from the Tax Office to pay capital gains tax of thousands more and the Department of Social Security advises her that the gift reduces her aged pension because of the rule of non-abandonment.

Instead, if the will bequeaths everything to a testamentary trust controlled by the spouse all of the heartache and tax could have been managed. By simply leaving a bequest to a trust controlled by the nominated beneficiary you are not ‘ruling from the grave’ as many imagine but rather you are giving all the benefits of control with the flexibility of joint ownership. The surviving spouse would still have full control of who gets what from the estate. She can give everything to herself or give some things to her children, grandchildren or any of the extended family as she wishes.

The holiday house could have been distributed to the children from the testamentary trust set up by the father so there would be no stamp duty payable. There would be no deemed disposal of the property so there wouldn’t be a CGT bill for the mother and it would have no impact on her pension entitlement. The flexibility of control of the assets and the income from any investments via a trust can be enormous.

If children under 18 years of age get their income from paid work then it is taxed at adult tax rates (eg. first $18,200 tax-free). On ‘unearned’ investment income only the first $415 is tax-free. After this, the next $892 is taxed at a punitive 66 per cent and then any amount over $1308 is taxed at 45 per cent. Distributions from family trusts or dividends and interest are considered to be ‘unearned’ income. Testamentary trust are exempt from this penalty tax regime and there can be great benefits in distributing the earnings to family members with children who can benefit from the favorable adult tax rates. This can include grandchildren, nephews, nieces and cousins as well as children.

The large number of potential beneficiaries gives the ones you want to be in control of your gift the greatest flexibility. It is this flexibility that allows beneficiaries to minimize tax. If you are intent on leaving your estate to a number of your children, then by indicating in your will that you wish it to be left to separate testamentary trusts controlled by each of them will give them maximum flexibility.

If you have a daughter with four children of her own, she could have investments earnings of $72,800 (four times $18,200) before any tax need be paid. In her own name, those same investments would attract her marginal tax rate after accounting for other income and could be as high as 45 per cent.

It pays to get sound estate planning advice.