When investors think about reducing tax, they often focus on contributions, deductions, investment structures and portfolio decisions. There is another area where careful planning can make a meaningful difference: what happens to your wealth when you’re no longer around.

In this episode of Investing Compass, Mark and Shani explore the often overlooked connection between estate planning and tax by leaning on insights from Estate Planning expert, Abbey John.

A will is usually thought of as a document that simply determines who receives your assets, but the way those assets are structured and transferred can have significant consequences for the people you leave behind.

From superannuation and investment portfolios to the importance of getting the right structures in place, this episode looks at the decisions investors should consider before it’s too late.

You can find the full article here.

Many of our financial goals revolve around creating better lives for ourselves and for our families.

From saving for your children’s education to securing your retirement and estate planning, the decisions you make today will shape your financial future, as well as your family’s.

Thinking ahead

Are private school fees worth it? Shani looks at what you’re giving up by sending your kids to private school.

Want to set up your child for life? Joseph explores how to (almost) set up a child for life with $46 per week.

Are education bonds a tax effective way to save for your children and grandchildren’s education? Shani takes a look at how it compares to other investment structures.

Balancing potential parenthood and finances? Sim explores whether Millennials afford to have children.

Estate planning

Thinking about estate planning? Noel Whittaker gives some great advice in Estate planning made Simple Part I, Part II and his interview with James Gruber.

Having tough conversations? Get some tips on how to talk to your family about your will.

Avoid common mistakes: Avoiding wealth transfer pitfalls and how to create an airtight will when more than 50% of wills are contested.

What are the documents you need to protect yourself and your family? These are the essential documents to give you peace of mind.

Inheritance

How to incorporate an expected inheritance into your financial plan. The intergenerational wealth transfer is a hot topic. How should you incorporate any inheritances into your financial plan?

Your inheritance will likely be a house. What should you do with it? Shani looks at the implications of inheriting or bequeathing property. Shani also takes a look at your options when you inherit shares.

Should you give your children their inheritance before you die? The issue is likely to be aired more often as Baby Boomers in Australia get older, die richer and leave behind larger bequests.

Invest or pay off your mortgage? This Investing Compass episode explores what you should do when you receive an inheritance.

You can find the transcript below:

Mark LaMonica: Thanks to PocketSmith for sponsoring today’s episode. PocketSmith tracks your spending, income, and investments all in one place, so you get a holistic view of your finances. PocketSmith has a special deal for Investing Compass listeners. Get 50% off your first two months of the PocketSmith Foundation or Flourish Plans. To get your deal, go to PocketSmith.com/investingcompass or find the link in the podcast notes.

Shani Jayamanne: Welcome to another episode of Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situation, circumstances, or needs.

LaMonica: Did anyone make a new financial year resolution?

Jayamanne: Probably a lot to do with money.

LaMonica: Okay. Well, in that case, what can help you with that is buying our book. Invest Your Way.

Jayamanne: Yes. There’s some links in the episode description if you’d like to take a look at it.

LaMonica: And if you have bought the book and read it and most importantly liked it, or can just say nice things about something you don’t like, then we would love a review on Goodreads or Amazon. And we also have a special request from Will that if you’re watching this on YouTube and you are not subscribed to our YouTube channel, you should subscribe.

Jayamanne: Lots of appeals there.

LaMonica: Exactly.

Jayamanne: So today we’re going to talk about two things that are guaranteed in life, and that is death and taxes.

LaMonica: Sounds like a fun episode, Shani.

Jayamanne: Well, it is an interesting episode because a lot of people do glaze over taxes when it comes to death because Australia does not have any inheritance taxes. But the way assets are passed on can still trigger unnecessary tax bills, administrative delays, and missed opportunities.

LaMonica: And it is important to remember that although there’s no inheritance tax, income and capital gains generated from the asset that’s passed on are in most cases taxable.

Jayamanne: So for this episode, we leaned on insights from Abby John, who is an estate planning lawyer, and she shares that that the biggest misconception with estate planning is that it is purely about documenting your wishes, but it should also provide you options about where you are headed.

LaMonica: And Shani, you spoke to Abby and wrote an article, so that’s in the show notes, so that has some additional detail. But we’re going to talk a little bit about that conversation, and we will start with one of the biggest insights that she gave you, which is the cost of avoiding a will. So you may believe that your estate will be distributed in a fair way upon your death, even if you have a simple situation.

Jayamanne: Like me, I do have a will, but simply I don’t have any children and I have a husband, so I would just assume that everything would go to my husband. But would imagine it would be the same for you, Mark. Not to your husband, to your wife.

LaMonica: And not to your husband.

Jayamanne: Do you have a will?

LaMonica: I don’t, Shani.

Jayamanne: No. So maybe after this episode, you will be convinced to get one. And realistically, even if your situation is simple, this happens to most of us. Half of our wills are contested. So not having a will leaves you even more exposed to contests, complications, or delays.

LaMonica: And this can impact the amount of tax that your beneficiaries will pay. So one of the clearest examples is the family home. So under current tax rule rules, executors generally have two years from the date of death to sell a principal place of residence and retain that capital gains tax exemption.

Jayamanne: So basically, if your loved one dies, you have two years to sell that home and it will be capital gains tax-free.

LaMonica: But if you miss that two-year window, there’s little to no chance to save on that capital gains and maintain that capital gains exemption. And the issue here is that most of the time you’re holding on to a house for a very long period of time. So there could be significant capital gains attached to it. So that could be a massive tax savings that you will get just from having a will.

Jayamanne: Now, you can appeal to have an extension granted, but this involves legal and admin fees that can be avoided. So without a valid will, the situation might be that your family spends months determining who can act as administrator of the estate, potentially delaying the sale of assets and increasing legal and tax costs.

LaMonica: And Shani has written a deep dive article on what to do if you inherit a house. So that article is linked in the article that you wrote about your conversation with Abby John.

Jayamanne: Okay, so let’s move on to testamentary trusts. A lot of simpler wills just look to divide assets without considering how the beneficiaries of the will, will receive them. And that includes the tax that they’ll pay on sale or on income generated by the assets that they inherit.

LaMonica: And testamentary trusts are a good way to do this for those that, of course, have the circumstances that they sue. So they’re powerful estate planning tools where a trust is created through the will, which only becomes active after death. So rather than receiving assets in your personal name, the inheritance is held within a trust structure.

Jayamanne: And when I spoke to Abby about testamentary trusts, she described them as the most tax advantageous and protective way to receive an inheritance. And that sounds pretty good. So she called out a few benefits that it gives you asset protection from creditors and bankruptcy. So the estate assets are protected if you’re in a poor financial situation where you might have creditors chasing you.

LaMonica: There’s also greater flexibility over distributions, potential tax savings through income splitting, and protection in family law disputes. But this episode is about tax, so we’re going to focus on that. So one of the greatest advantages of a testamentary trust is that it allows distributions to minors to be taxed at adult tax rates instead of minor tax rates.

Jayamanne: And tax rates for minors are high. You can earn up to $416 tax-free, which is much lower than the $18,200 tax-free threshold for adults. Then anything above $416 to $1,307 is at a 66% tax rate. Anything over that $1,307 is at 45%. So the adult tax rates are much more attractive. So families can use testamentary trust to distribute income to children or grandchildren in a tax effective way that helps fund expenses such as education costs that they might have.

LaMonica: But just like everything else, you need to look at the costs versus the benefits you’ll receive. So Abby charges around $1,100 for a simple will. A will with a testamentary trust costs roughly $2,000. So that trust is dormant until death, so it does not create any ongoing costs while the will maker is still alive. As a rough guide, she says estates of around $250,000 per beneficiary may justify from having this structure.

Jayamanne: But testamentary trusts are not for everyone. They may not make sense for beneficiaries who permanently live overseas and are not Australian tax residents. They do not receive the benefits of structuring for tax minimization. If the inheritance is relatively small, the ongoing accounting and tax return costs may outweigh any potential benefits.

LaMonica: So let’s talk about super. It is one of the most tax sensitive assets in an estate because it does not automatically form part of your will. With super, it’s governed by the rules of the super fund and your binding death benefit nomination. So the trustee of the superfund makes a decision about where your super benefit goes.

Jayamanne: And a binding death benefit nomination is a legal nomination, but it needs to be made out to a valid dependent. So in most cases, that is your spouse or your children. The issue is that adult children are not considered a tax dependent, so they can face tax when inheriting super directly. If you want to know more about who qualifies as a dependent and how much tax they’ll pay, I’ve written an article on that as well, and it’s linked in the original article.

LaMonica: So in some situations, especially in the case of adult children, directing super benefits to the estate instead of directly to adult children may reduce the overall tax burden. So you do that by nominating your legal personal representative or LPR on your binding death nomination form instead of nominating them directly. And that means that adult children will pay tax minus the 2% Medicare levy. So that doesn’t sound like much, that 2% savings, but on large estates, that can be a meaningful amount, especially with super balances that often make up the largest assets, one of the largest assets that people hold.

Jayamanne: But importantly, this only works if the estate plan and binding death benefit nomination are properly aligned. Your will and your nomination need to reflect the same thing. All right. So lastly, I think we can talk about the biggest mistake with wills. So I asked Abby what were the most common mistakes that she sees, and she called out DIY or post office wills. They can make an already emotional situation more complex.

LaMonica: And that’s because these wills are generic templates that don’t take your personal situation or circumstances into account. So they’re basically a catch-all for the general population and won’t cover any intricacies in your own situation. And when you have broad and general wording in these documents, as they normally do, the document can be left open to interpretation. An estate planning language really needs to be precise because your executors are enacting your wishes and they’re relying entirely on the wording of the document when they’re administering an estate.

Jayamanne: And if it is left up to interpretation, that means that any ambiguity can increase the risk of disputes and can expose executors to personal liabilities. So they may become personally liable for the decisions made in distributing assets in the will if there is a contest. Lastly, I finish the conversation with Abby by asking what three things each of us can do to improve the tax effectiveness of an estate plan. So do you want to call them out, Mark?

LaMonica: I do. So number one is make sure that you do periodic reviews, make sure that the people in your will and the circumstances, your personal circumstances and their circumstances haven’t changed. The second is assessing whether you have grown your assets to a point where a simple will isn’t enough to manage and protect your estate. And the last is to ensure that your super and your will are speaking to each other and ensure that your binding death benefit nomination aligns with your estate plan.

Jayamanne: Above all, it’s important that you’re not avoiding estate planning because it makes you feel uncomfortable. You’re going to create situations that are multitudes more uncomfortable if there are contests, and doing this means that you have the best chances of making sure that your wishes are being honored and you’re avoiding any potential conflict at an already emotional time.

LaMonica: Alright, so that is our episode on wills. And we do want to mention one more Will, and that of course is Will, who is the producer of this podcast. And you want to make Will happy by going to our YouTube page and subscribing to our channel.

Thank you very much for listening.

Invest Your Way

A message from Mark and Shani

For the past five years, we’ve released a weekly podcast and written on morningstar.com.au to arm you with the tools to invest successfully. We’ve always strived to provide independent, thoughtful analysis, backed by the work of hundreds of researchers and professionals at Morningstar.

We’ve shared our journeys with you, and you’ve shared back. We’ve listened to what you’re after and created a companion for your investing journey – Invest Your Way. Invest Your Way is a book that focuses on the investor, instead of the investments. It is a guide to successful investing, with actionable insights and practical applications.

If anyone would like to support this project you can buy the book now. Thanks in advance!

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