The fundamentals of Estate planning

Benjamin Franklin once made the famous quote - “there are only two things certain in life: death and taxes”.

And while we all know that both are indeed certain, Estate planning remains an often overlooked aspect of managing one's finances.

It's understandable why this may be the case. It's human nature to delay addressing matters that are perceived to be a distant concern. And although no one likes to think about their eventual passing, it is extremely important to consider how your affairs will be managed in the event of you passing away. You’ve worked hard to accumulate your wealth, the next step is to ensure that it is transferred in accordance with your wishes, in the most tax effective way possible.

In this article, we are going to cover the fundamentals of Estate planning, discussing the general considerations that the majority of Australian’s should be thinking about.

My aim is to help educate you on the importance of Estate planning, so that you can put in place more effective strategies, and have deeper discussions with your professional advisors regarding this important subject.

What is Estate planning?

Estate planning is the process of considering and formally documenting how you want your assets and liabilities distributed when you pass away.

This is typically documented through a Will, but as not all of your assets form part of your Will, extra steps are required to ensure that any assets that do not form part of your Will, are also distributed in accordance with your wishes.

While many people treat creating a Will as the extent of their Estate planning, this is only the first step. It is important that you also consider:

• Maintaining appropriate levels of insurance

• Advanced Health Directives

• Enduring Power of Attorneys and Power of Attorneys

• Tax effectiveness of distributions

• Asset protection strategies

Why is estate planning important?

When you pass away without a Will, your assets will be distributed in accordance with the laws of the state or territory you live in.

Some might breathe a sigh of relief knowing this, however, this isn’t a great outcome because:

• Without clear instruction, the Courts may distribute your assets in a way that is not what you wanted, and/or in a way that is not tax effective;
  

• You will be creating complexity by not having clear instructions about how your Estate should be administered; and
  

• It is likely that as a result of all of the above, your Estate will be somewhat eroded by fees and tax, diluting the value of assets you are able to transfer to your beneficiaries.

Consider the following scenario. I know it might be a slim chance of occurring, but it shows the disaster that not planning for the future can entail.

"A married couple are on the edge of divorce. They haven’t formalised their plans yet but they are rapidly drifting apart. Their family is blended, made up of two children to the husband and two children to the mother. Sadly, the husband is involved in a car crash, and passes away. His Will has not been updated in some time and his current Will leaves everything to his wife. Upon receiving her inheritance, his wife updates her Will, to leave the assets only to her children. The husband’s children effectively receive no inheritance as a result".

As mentioned, this is an extreme example, but an example nonetheless of how poor planning can achieve seriously detrimental outcomes.

You may be thinking this is a one in a million scenario, but the truth is, not having a Will and not considering your affairs leaves you open to risk. As small a chance as this scenario might be, scenarios such as these play out everyday across the world.

Estate planning considerations

At the core of Estate planning is answering the question ‘how would I like my assets distributed when I pass away’, and then formally documenting the answer to this question in your Will.

As part of this, consideration should be given to:

• Who will be the Executor of your Estate?

• What assets form part of your Estate?

• Are your assets sufficient to provide an appropriate lifestyle for your surviving spouse and children?

• Is asset protection from unscrupulous family members required? i.e. ‘keeping the money in the family’.

• What is the most tax effective way to distribute your assets?

• Who will your beneficiaries be?

We will discuss each of these considerations in more detail below.

The role of the Executor

A key consideration is deciding who the Executor of your Estate will be.

The Executor is the person that is responsible for ensuring that the Will is executed in accordance with your wishes. This is an important role that encompasses things such as liaising with your solicitor and tax agent, paying any final bills, re-negotiating loans, collecting final income, closing bank accounts, providing documentation to lodge final tax return etc. Basically they act on your behalf to finalise your affairs. Although it depends on the size of your Estate, the role may take a number of years to complete.

Generally, your spouse would act as the Executor of your Estate, but another trusted friend or family member can also fulfil this role. You may wish to also nominate an Executor to act where both you and your spouse pass away at the same time.

Whomever you choose, we recommend you notify the intended Executor in advance and ensure they are comfortable accepting the role, prior to nominating them in your Will.

What assets and liabilities form part of my Estate?

Assets and liabilities that you own in your personal name generally form part of your Estate. However, there is some complexity here.

Firstly, for any jointly owned assets, it is important to identify the ownership structure. Generally, there are two main ownership structures for jointly owned assets - either ‘joint tenancy’ or as ‘tenants in common’:

• Joint tenancy is when one or more parties own an asset together. When one party dies, the ownership of the asset is automatically transferred to the surviving owner. If any of your assets are owned as ‘joint tenancy’, those assets will immediately transfer to the other owner(s) upon your passing, and will not form part of your Estate. In effect, any assets owned via joint tenancy bypass your Estate and are immediately transferred to the surviving owner(s). This is quite typical of the family home and joint bank accounts which are often owned equally between spouses.
  

• Tenants in common is an alternative ownership structure for joint assets. Under this ownership structure, each owner has a separate and identifiable interest in their asset, and your proportion of the ownership is able to be separately identified in your Will. Accordingly, these assets form part of your Will, and can then be distributed in accordance with your wishes as documented in your Will.

The following assets are also generally excluded from your Estate, and therefore require separate consideration above and beyond what is detailed in your Will:

• Superannuation assets Superannuation is generally excluded from your Estate as it is held in a Trust on your behalf. However, if you do not appoint a beneficiary of your superfund, the proceeds of your fund will likely be paid to your Estate, where it will be dealt with under your Will.
  

• Assets held in a trust or company Any assets that are held in a trust or a company do not part of your Estate. In your Will, you therefore need to nominate who will be the Director or Trustees of these entities, or attend to these assignments prior to your passing.
  

• Insurance proceeds where a beneficiary is nominated Payouts received from insurance policies will also bypass your Will when a beneficiary has been nominated. For example, if you hold a Life and TPD policy and have nominated your spouse as the beneficiary, the proceeds will be paid directly to your spouse, instead of forming part of your Estate. Making sure your nominated beneficiaries remains up-to-date is important in achieving tax minimisation and asset protection.

The role of insurance in an Estate plan

It probably seems counter intuitive talking about insurance as part of your Estate plan, but it is an important consideration for those that have not yet reached financial independence.

When developing an Estate plan, it is important to consider how your family would be impacted in the event you pass away, and implementing appropriate strategies to allow your family to best manage in your absence.

Consider the following scenarios:

• If you passed away, would your surviving spouse have the financial means to repay your debts? In particular, having insufficient insurance to pay off your home loan in the event of you passing away can leave your spouse in a situation where they may need to sell the family home.
  

• Does your spouse have sufficient earning capacity to maintain the lifestyle you want for your children? An important consideration here is that if all of the parenting responsibilities are left with one parent, this can take away from time that can be committed to growing their income and career. This can affect their quality of life and that of your children. Again, insurance can help address this.
  

• Would your current insurance payouts be sufficient to cover your debts and fund future child expenses such as school fees? Ensuring that you have sufficient insurance coverage to fund anticipated future expenses is an important Estate planning consideration.
  

• Does your current insurance cover adequately compensate your spouse for the loss of earnings over the course of your life? If you were to pass away now, what would the loss of your earnings mean for your family, and do you wish to take out sufficient insurance to cover the loss of your earnings?

For those in business, additional insurance considerations may be required. For many business owners, their financial wealth is tied up in their business. Accordingly, they may wish to consider whether additional insurance is required to ensure the surviving family members are appropriately compensated for the value of the business. A key consideration here may be Key Person Insurance, or buy-sell insurance if there are business partners involved.

Part of your considerations with insurance should not just be how much you insure yourself for, but who the intended beneficiaries are. There are different tax and asset protection strategies here depending on who the beneficiary is, so utilise the services of a trusted professional to help you navigate the complexity.

With insurance, there is always a tradeoff between paying higher premiums for higher coverage.

You can generally review your insurances with the current provider and they can provide guidance regarding whether you are appropriately insured.

Advanced Health Directives and Power of Attorneys

If you are alive, your Will is not yet active. However, scenarios may eventuate where you are alive, but unable to make financial decisions due to being incapacitated.

Accordingly, in addition to a Will, you may also wish to consider having the following documents created:

• Power of Attorney A Power of Attorney is a legal document that allows another person to act on your behalf. It is generally active for a specified period, such as a house sale, and generally lasts until the completion of this activity. Generally, a POA will also cease applying if you lose mental capacity, at that point, an Enduring Power of Attorney is required.
  

• Enduring Power of Attorney An Enduring Power of Attorney is a legal document that allows a representative to act on your behalf, and can apply in the scenario where you have lost your mental capacity. The representative is generally a trusted family member or your spouse. These can be useful in appointing a representative to move forward your financial and legal matters where you do not have the mental capacity to do so.
  

• Advanced Health Directive An Advanced Health Directive is similar to a POA, however it applies specifically to health matters. The idea is to explain your health wishes, allowing your nominated representative to fulfil those wishes on your behalf.

Having these documents in place can make access to financial accounts much easier, help move forward medical procedures and help administer your affairs.

Without these legal documents in place, your spouse or family may be unable to make financial decisions on your behalf, such as speaking to your insurance provider, or putting you into health care. With these documents in place, it alleviates the complexity that comes with dealing with these types of decisions, allowing you to act faster than would be the case without these documents.

The role of a Testamentary Trust in Estate planning

A key consideration for those creating or updating their Will is whether a Testamentary Trust is an appropriate mechanism for distributing assets to their beneficiaries.

A Testamentary Trust is a trust structure that is generally created on the death of the Will maker. By transferring assets into a trust, you can achieve both tax efficiencies and asset protection for your beneficiaries.

Tax efficiencies can be achieved in the following ways through use of the Testamentary Trust structure:

• Generally children under 18 years of age are subject to punitive tax rates on investment earnings. This means children can be taxed as much as 45% for eligible income over $1,307, which is extremely high. However, under a Testamentary Trust, your children will be taxed at adult rates, effectively allowing your children to receive $18,200 of income tax free.
  

• Each year, the trustee of the Testamentary Trust is able to decide how the income will be distributed. This allows some degree of flexibility to take advantage of different tax rates and circumstances for each of the beneficiaries, helping the money go further by being more tax efficient.
  

• A Testamentary Trust may be constructed to exist until the beneficiary reaches a nominated age, such as 21 years of age. At that point in time, the assets in the Testamentary Trust can generally be transferred to the beneficiary without triggering Capital Gains Tax. This helps protect the value of the asset so that it isn’t eroded by tax (noting however that if the beneficiary later sells the asset, Capital Gains Tax will be payable at that point).
  

• If you have Life insurance, you can choose who to nominate as your beneficiary. The potential beneficiaries may typically include your surviving spouse, children, your Estate or a Testamentary Trust established on your passing. Having your insurance proceeds paid into the Testamentary Trust can be an effective strategy, as the investment returns from these funds can be distributed to your child beneficiaries, and minors can pay then tax at adult rates.

Testamentary Trusts also allow asset protection:

• As your children may receive a substantial amount of assets, it makes sense to protect these assets. After all, these assets are there for your children. Testamentary Trusts can be established so that they keep the wealth in the bloodline. This can potentially protect these assets in the event of your children divorcing.
  

• If you are the beneficiary of a Testamentary Trust, the original Testamentary Trust may be set up so that when you pass away, these assets are then on trust for the benefit of your children. This can act as another strategy to keep the assets within the family.
  

• Testamentary Trusts are also generally exempt from bankruptcy and divorce proceedings.
  

• In its own way, by having a Trustee (the controller of the trust), the use of a Testamentary Trust structure can also protect the wealth from poor financial choices the beneficiary may make. Imagine a 15 year old receiving $500,000 in assets versus a 30 year old receiving the same amount. By holding the assets in a Testamentary Trust, you can protect the assets from wealth destruction and frivolous spending by not providing access to these funds when your child beneficiaries are too young to financially understand the repercussions of their actions.

If you use a Testamentary Trust, thought needs to be given to who will be the Trustee - the person who operates the trust and manages obligations such as investment decisions and the lodgement of tax returns. This will often be the surviving spouse or a trusted family member. Where the beneficiary is already an adult, they can be trustee of their own Testamentary Trust as well.

Whether a Testamentary Trust is suitable depends on your personal circumstances, and you should discuss the suitability of this ownership structure with your trusted advisors.

Minimising contention

When you pass away, your Will is able to be challenged. Challenges may come from excluded beneficiaries, who feel they have an entitlement to a distribution. Challenges can also exist between beneficiaries, where they perceive that there has been an inequitable distribution of Estate assets. The purpose of a challenge is generally to override or alter the Will, for the purpose of a beneficiary receiving a larger distribution.

While there is no way to completely safeguard your Will from being challenged, there are strategies that can be put in place to minimise the impact of challenges. These strategies typically include:

• Distributing assets while you are still alive. That way there are less assets in your Will to be challenged.
  

• Instead of holding assets personally, consider utilising a structure such as a company or a trust to hold assets, and then transferring control of those assets to the intended beneficiaries while you are still alive. But beware with this strategy, as if you relinquish all control, you might not be able to control how that person manages the assets. Unfortunately there are unscrupulous people out there that are all too eager to do the wrong thing.
  

• Buying assets utilising the joint tenancy ownership structure, so that the assets are immediately transferred to the surviving owner when you pass away.
  

It is important to say that no strategy is bulletproof, however working to put in place effective strategies is much better than doing nothing and leaving your Estate open for contention.

Consideration for superannuation assets

Superannuation is generally separate to your personal assets and therefore does not generally form part of your Estate or Will preparation considerations. Accordingly, you instead need to notify your superannuation fund where you would like your super benefits to be paid in the event of your passing.

Generally, it is most tax effective to have your super benefits paid to the surviving spouse or child that is under 18 years of age.

To provide instruction on how your super will be distributed when you pass away, you are typically required to make a Binding Death Benefit Nomination and you can contact your superfund about this (it may even be able to be completed online if your fund allows this).

If you prepare a Binding Death Benefit Nomination, it is important to check whether this expires after a period of time (and if it does, remember to keep it up to date).

Alternatively, you can have your super benefits paid into your Estate where it is administered by the Executor, but this is typically less tax effective (tax at up to 32% may be payable depending on the circumstances).

If your super is transferred to your Estate upon passing (due to not nominating a preferred beneficiary), then this amount is up for challenge as it would form part of the Estate assets (whereas if it goes directly to a nominated beneficiary it bypasses the Will and is harder to challenge).

Some people are diagnosed with an incurable disease, but have advanced warning. Depending on your age (and this will generally be applicable for those over 60 years of age), you may have the option to withdraw your money from super tax free while you are alive. This can be significantly more tax effective as if super passes to your Estate, it may be taxed depending on who the nominated beneficiaries are. While this option allows you to save tax, you can also distribute the money to your beneficiaries while you are alive, leaving less assets in your Estate available for contention.

Additional considerations:

While we have focussed on the key areas of Estate planning, for completeness, there are additional considerations worth mentioning:

• If you have any beneficiaries that live overseas, the tax implications are typically more complex here, so seek professional advice.
  

• I would try to avoid using templated Wills or ‘Will kits”. Although cheap, they are often easily disputed due to being incorrectly prepared.
  

• Guardianship needs to be considered if you have children, as a situation may eventuate where both parents pass away at the same time.
  

• While you would not normally individually nominate where you would like every asset you own distributed, it can be worth nominating intended beneficiaries for heirloom assets.

Additionally, I’m a strong believer that you should let your beneficiaries know your intended wishes prior to passing away. This helps explain why certain decisions were made and helps your beneficiaries understand your wishes, which hopefully results in less contention.

Keeping your Will up-to-date

It almost goes without say, but I’m going to say it anyway. Once the Will is created, it is important to review it regularly to make sure it remains current and continues to reflect your wishes.

Changes that may impact on your Will include:

• The passing of a beneficiary

• Wishing to appoint additional beneficiaries, or remove beneficiaries

• Sale of specified assets, or acquisition of more assets that require separate consideration

• Divorce, or remarrying

• Tax changes that impact your proposed plans

Having a clear estate plan gives guidance to your family about how your assets should be distributed, and minimises ambiguity and the potential for challenges against your assets.

This article scrapes the surface of Estate planning issues, so please work with your trusted advisors to implement a suitable Estate plan.

If you have any more tips, please mention these in the comments below.