FNCE20003 Introductory Personal Finance Lecture 9 PDF

FNCE20003 Introductory Personal Finance Lecture 9 Estate Planning Lecturer – Tony Cusack September 2024  Lecture 9 topics What is estate planning? Wills – Executors and probate – Intestacy Non-estate assets Powers of attorney Trusts September 2024...

FNCE20003 Introductory Personal Finance Lecture 9 Estate Planning Lecturer – Tony Cusack September 2024  Lecture 9 topics What is estate planning? Wills – Executors and probate – Intestacy Non-estate assets Powers of attorney Trusts September 2024 FNCE20003 Lecture 9 2  What is estate planning? to this point, we have covered financial wellbeing, focusing on wealth creation / maintenance, and the RIS objective distribution of wealth after death has only been briefly mentioned but in recent years, there has been a greater recognition of the importance of distribution and succession of wealth to future generations as a result, estate planning has emerged as a vital part of an individual’s overall financial planning estate planning can be defined as the planning and documentation of the wishes of a person for the distribution of all assets under their control, following their death September 2024 FNCE20003 Lecture 9 3  Estate planning effective estate planning seeks to ensure that assets go to the right beneficiary, at the most appropriate time, in the most tax-effective manner it aims to provide a straightforward transition to the client’s beneficiaries on death, taking into account the circumstances of the beneficiaries the following are the desirable features of an estate plan: – administratively simple – inexpensive to maintain – a balance of life-time enjoyment and preserving wealth for family members – reviewed regularly September 2024 FNCE20003 Lecture 9 4  Estate plans key elements of an estate plan – will – appointment of executor – establishment of a trust? – Power of Attorney (PoA) since Financial Planners are generalists, they can prepare the estate planning ‘road map’, but will not generally be directly involved in the preparation or execution of legal documents (e.g. wills) – i.e. the FP can provide related financial planning advice, but should recommend that the client seek further specialist estate planning advice September 2024 FNCE20003 Lecture 9 5  Definitions / jargon Testator (if male) or a Testatrix (if female) – the person making a will Beneficiaries – persons who collectively are entitled to receive all or part of the estate of a deceased person, in accordance with the terms of a will or the laws of intestacy Bequest – a gift of property, etc. Devise – a gift of land in a will to a nominated beneficiary Legacy – a gift of personal property, etc. Executor / Executrix – the person named in a will and appointed to look after the estate of a deceased person, including winding it up (also known as the Legal Personal Representative, LPR) September 2024 FNCE20003 Lecture 9 6  Definitions / jargon Estate assets / Non-Estate assets – see next slide Trustee – holds property in trust for another Corporate trustee – a trustee set up as a company (typically for limited liability reasons) Guardian – person appointed in a will or court order to care for and manage the affairs of a beneficiary such as a minor Ademption – complete or partial extinction of a legacy by an act of the testator (other than revocation) during his/her lifetime – the classic example is prior (to death) sale of a will asset September 2024 FNCE20003 Lecture 9 7  Estate v non-estate assets assets that are owned in the personal name of the individual will be included in their estate (by definition) – accordingly, all real property, financial assets (cash, shares, loans, etc.), personal and household items, cars, collectibles, etc. are estate assets on the other hand, assets that are controlled but not owned by the individual are generally deemed “non-estate assets”, e.g. – these include jointly-owned assets (e.g. home), unreleased superannuation benefits, assets held in trust, life insurance proceeds, and such estate assets are (must be) dealt with by wills, but additional planning is often required in relation to the distribution of non-estate assets September 2024 FNCE20003 Lecture 9 8  Wills a will is a legal document that disposes of a deceased estate’s assets to the people intended it specifies how property is to be dealt with after the death of the testator, and provides: – directions as to who are the beneficiaries to the assets and income of the estate – directions in the event that a beneficiary should die before the testator dies – nomination of executor(s) to manage the deceased estate – nomination of guardians for minors – any other specific directions by the deceased September 2024 FNCE20003 Lecture 9 9  Wills – applicable laws Wills Act 1997 (commenced 20/7/98) Wills Act 1958 (applies to wills made before 20/7/98) Administration and Probate Act 1958 (contains the formula for distributing assets when there is no will and contains the provisions about challenging a will) September 2024 FNCE20003 Lecture 9 10  Who can make a will? anyone over the age of 18 who has testamentary capacity (i.e. is of ‘sound mind’) can make a will – exceptions to the age 18 rule are married minors, court authorised ‘sound mind’ means having sufficient capacity to understand the nature of: – the act of making a will and its effects – what they are doing by signing the will – the property to be willed to the beneficiaries must not be made under duress or coercion September 2024 FNCE20003 Lecture 9 11  Making a valid will to be valid, all wills must be in writing (they don’t necessarily have to follow a set format, but that is recommended) the testator(rix) must sign the will him/herself, or it must be signed by someone else in his/her presence and at his/her direction a will must be executed in the presence of two independent witnesses (in presence of each other) a will does not necessarily have to be prepared by a solicitor (but it is advisable, especially if financial arrangements are complicated) September 2024 FNCE20003 Lecture 9 12  Form of a will no set form, but a recognised order exists (see examples): – name, address and occupation of the testator – revocation of former wills – appointment of executor and trustee – specific gifts of personal estate – specific gifts of real estate – life interests – residual interests – maintenance and provision for infants – declarations of intentions and appointment of guardians – disposal of body and funeral arrangements September 2024 FNCE20003 Lecture 9 13  Preparing a will key factors to consider in preparing a will: – what assets do I have now, and may I have in the future, to give away? – to whom do I wish to leave them? – who is going to have the task of handing over the assets and look after my estate (i.e. who will be my executor)? – what powers does my executor need? incomplete wills: note that the Wills Act 1997 allows the Supreme Court to verify a will, even if some of the formalities are wrong – famous case: http://www.turnbullhill.com.au/articles/remember-brett-whiteley--great- artist-but-a-terrible--would-be-lawyer-.html (who was Brett Whiteley?) September 2024 FNCE20003 Lecture 9 14  Life (duration) of a will once a will is valid and signed, it remains valid until it is revoked voluntary revocation – if a will is redrafted, or a new will made involuntary revocation – marriage automatically revokes a will – however, divorce and separation do not revoke a will with some minor exceptions, depending on when the will was made September 2024 FNCE20003 Lecture 9 15  Changing a will a will can be changed by preparing a codicil – technically, a codicil is simply defined as an additional will, but it will usually only relate to a specific aspect of the will – it is the most effective way of amending an existing will, but is recommended for simple amendments only executed as a separate document alternatively, as noted, preparing a new will automatically revokes an older one September 2024 FNCE20003 Lecture 9 16  Beneficiaries beneficiaries can be family members, friends, charities, creditors and other entities – in theory, there is no restriction on who a testator chooses as a beneficiary issues to be considered for distributions to beneficiaries: – eligibility to age pension – exposure to risk (bankruptcy) – taxation status – ability to manage finances – potential family law problems September 2024 FNCE20003 Lecture 9 17  Choosing an executor / LPR the executor / LPR ensures that a testator’s instructions are carried out and associated duties are completed no special qualifications are needed, but you should consider if they are up to the task it can be a natural person (principal beneficiary, relative), Public Trustee, trustee company or professional adviser generally, the executor’s role is voluntary and not paid unless expressly provided you should also consider appointing a substitute executor September 2024 FNCE20003 Lecture 9 18  Responsibilities of an executor can be demanding and time consuming needs good business and organisational skills – take control of body, locate the will, arrange (and pay for) the funeral – identify, collect, control and protect the assets – identify and pay all liabilities – obtain a ‘grant of probate’ of the will – pay the costs of administering the estate – distribute the assets – lodge tax returns and pay taxes (usually requires two ITRs in the year of death) – defend the will if there are any challenges September 2024 FNCE20003 Lecture 9 19  Deceased Estates recall that an estate is the net worth of a person at a given point in time, whether alive or dead deceased estates – specifically relating to the latter – cannot be dealt with until a grant of representation is obtained – either by probate or by Letters of Administration the process commences with the placing by the executor of appropriate newspaper advertisements notifying of an intention to deal with assets following the lapse of a statutory time period, an application may be made to the Registrar of Probates (of the Supreme Court) September 2024 FNCE20003 Lecture 9 20  Probate in most cases, an executor will be required to obtain a grant of probate to take possession of the estate assets (as testator’s legal representative) this is the formal process by which a will is proved as ‘last will and testament’, to confirm executor, and to be registered with the Court it evidences that proper administration of the estate has been completed a probate parchment is then issued, with the will attached institutions or organisations holding assets of deceased will typically request a sighting of the Probate before releasing the assets to the executor (e.g. bank balances, listed share investments, etc.) September 2024 FNCE20003 Lecture 9 21  Letters of Administration in cases where probate cannot be obtained (e.g. no valid will, or no executor), the court’s approval for someone to administer the estate of a person is provided by Letters of Administration the reason for considering the appointment of a substitute executor is that there will be a problem with administering a deceased estate if the nominated executor is unable to act – probate can’t be obtained – e.g. you have appointed your spouse as executor of your estate, but you are both killed in a car accident typically, the principal beneficiary or nearest next of kin applies to become estate administrator by obtaining a grant of ‘Letters of Administration’ September 2024 FNCE20003 Lecture 9 22  Intestacy Full intestacy occurs when: – a will is not made, or – a will is made but cannot be admitted to probate as its execution was obtained under duress, or the deceased lacked testamentary capacity Partial intestacy occurs when the will does not dispose of all the estate assets, a particular bequest is invalid, a beneficiary predeceases the testator, or by operation of the “doctrine of forfeiture” – latter is where a person entitled to an interest is criminally responsible for the death of the testator September 2024 FNCE20003 Lecture 9 23  Rules of intestacy an administrator will need to be appointed (usually next of kin) by way of Letters of Administration the administer is required to follow the statutory rules of intestacy, which prescribe precise rules relating to distributing estate assets the fundamental principle of distribution under these rules is that they are governed by marital and blood relationships what happens if a person dies without a will and without dependants? – distribution is based on next of kin, if any – in Australia, specific rules depend upon the state of residence September 2024 FNCE20003 Lecture 9 24  Intestacy distributions each Australian state has different rules, e.g. in Victoria, the administrator first needs to establish a current family tree and distribute as follows: – first, to your surviving spouse / partner (first $100,000, plus 1/3 of balance of estate; the remainder is split equally between children; if there are no children, the spouse gets everything) – if no surviving spouse, to your children – equally – if no surviving spouse or children, to any living next of kin (first parents; if none surviving, siblings; if none surviving, others such as grandparents, uncles and aunts, cousins) – if none of the above, to the Crown (i.e. government) September 2024 FNCE20003 Lecture 9 25  Distributing estate assets to re-iterate, estate assets are assets that are owned in the personal name of the will maker (e.g. goods, chattels, property) estate assets are the assets that are capable of being disposed of by a will an issue that arises is that asset distributions under a will are vulnerable to challenges by unhappy family members or other claimants – any claimants would need to meet specific criteria to challenge a will wills are also vulnerable to access by a client’s financial creditors if s/he dies an undischarged bankrupt (unless protected by legislation) September 2024 FNCE20003 Lecture 9 26  Contesting a will the general rule is that a person can leave assets to whomever they wish (there is no obligation on anyone to allocate equally, or fairly) under common law, wills can be challenged on grounds of: – lack of testamentary capacity – undue duress – incorrect execution persons can have the legal costs of contesting a will paid out of the estate (such claim must be made within 6 months from Probate) – but not if the challenge is deemed to have no appropriate basis September 2024 FNCE20003 Lecture 9 27  Contesting a will the general principle of ‘no restriction on beneficiary choices’ is modified by Family Law, which imposes a responsibility to make provision for family / others if inadequate provision is made, a person can make an application to contest under the Testator’s Family Maintenance Act 1912 (TFM claim) TFM claims are limited to the following people: – surviving spouse or de facto – children (including ex-nuptial, adopted and stepchildren) – parents (if you die without a spouse or children) – a divorced spouse who is receiving or entitled to receive maintenance from you at the date of your death September 2024 FNCE20003 Lecture 9 28  Estate challenges in addition, each state has legislation granting the right to challenge a person’s estate (not specifically distributions by the will) to persons who can establish a right to maintenance by that person examples of potential claimants include: – estranged children whom the testator might want to disinherit – ‘unknown’ children who might claim paternity of a deceased testator – long-term carers of a testator one key general rule remains – only a person’s estate assets are vulnerable to an estate challenge September 2024 FNCE20003 Lecture 9 29  Non-estate assets as we noted, non-estate assets are not distributed by a will; they include – jointly owned assets (the survivor is generally entitled to sole ownership) but not assets held as ‘tenants in common’ (ownership shares are separate and are included in deceased estates, i.e. they are estate assets) https://legalvision.com.au/joint-tenancy-and-tenants-in-common/ – trust assets, including superannuation entitlements (the fund Trust Deed typically distributes to the most appropriate person(s), e.g. spouse) – life insurance (depends on who owns the life policy; if the person who took out the policy dies, then the amount of the claim is an asset of the estate) – assets dealt with by Binding Financial Agreements September 2024 FNCE20003 Lecture 9 30  Binding Financial Agreements Binding Financial Agreements (BFAs) can be used to regulate financial and other arrangements, typically related to marriage commonly referred to as pre-nuptial agreements (but broader), BFAs detail agreed outcomes relating to separation, divorce, and even on death essentially deadlock-breaking devices, parties should give consideration to BFAs at the time when they are most amenable to considering them – i.e. in advance of when they might be needed … if a BFA is properly drawn up, they are enforceable, and the agreed provisions can be put into effect (they override Family Court’s jurisdiction) – but sometimes they do not address changing circumstances well enough September 2024 FNCE20003 Lecture 9 31  Binding Financial Agreements so, BFAs outline the financial consequences to each of the parties on relationship or marital breakdown such certainty of outcome may be necessary because of the significant wealth that one partner has compared with that of the spouse, or because the client is in business with third parties – i.e. a BFA could provide certainty that the business would not have to be sold as a result of a claim by a spouse in the future – this is prudent for the running of some businesses – so, a BFA can give protection not only to families, but also to business partners September 2024 FNCE20003 Lecture 9 32  Three-year rule for tax Australian tax law allows executors up to 3 years to finalise an estate during this time, the deceased estate is taxed as if an individual i.e. standard personal income tax rates apply to the income (interest, rent, dividends, etc.) earned by the estate assets this rule is essentially a concession granted by the ATO that may provide some tax savings benefits to beneficiaries e.g. where beneficiaries are in full employment and currently in top MTR, lower tax will apply to distributions delayed by the executor September 2024 FNCE20003 Lecture 9 33  Powers of Attorney (PoA) a PoA is a legal document under which a person (the donor) appoints another person (the attorney) to act as his/her agent – e.g. sign contracts, manage affairs, medical decisions a PoA operates only during the lifetime of the donor can be general (non-enduring) PoA, enduring (financial or medical), or power of guardianship a general PoA ceases to operate if the donor loses mental capacity to act in contrast, an enduring PoA will remain valid and applicable even if the donor loses their mental capacity to act September 2024 FNCE20003 Lecture 9 34  Powers of Attorney (PoA) a PoA authorises the attorney to undertake any specified legal, administrative or financial matter that the donor can undertake in his/her own right the donor must have capacity to execute a PoA for it to be valid (again, the concept of ‘sound mind’ applies) a donor may execute more than one PoA (and similarly, can revoke one or all PoA) PoA operates under state law and some jurisdictions require a PoA to be registered to be effective September 2024 FNCE20003 Lecture 9 35  What a PoA cannot do make a will for the donor undertake illegal acts delegate power to another (unless expressly specified by the PoA) exercise the donor’s power as trustee make decisions about the donor’s ‘lifestyle’, for instance in the matter of medical treatment (unless there is an express provision in the PoA as exists to a limited extent in Victoria or ACT) September 2024 FNCE20003 Lecture 9 36  Types of trusts a fixed trust (better known as unit trust) gives beneficiaries a fixed entitlement to distributions and capital in proportion to number of units held – as previously noted, they are similar to shares in a company a discretionary trust gives beneficiaries an entitlement to be considered for distributions from the trust but not the right to receive distributions there are two main types of trusts in the context of estate planning: 1. a living, or inter vivos, trust (established during a person’s lifetime), of which family trusts are a common example 2. a testamentary trust (established after the death of the testator, by the will) which only comes into effect upon the testator’s death September 2024 FNCE20003 Lecture 9 37  Family trust structure a (discretionary) family trust (FT) can be effective for tax and estate planning, as it enables family assets and income to be shared amongst beneficiaries e.g. if the parents own substantial income earning assets, perhaps including an operating business, these assets can be contributed to a FT and the income from the assets is earned in the name of the FT – the trustee holds the assets on behalf of the beneficiaries – income is distributed to beneficiaries at the discretion of the trustee, which can result in tax savings (or even assist in meeting expenses) – e.g. income distributed to a non-working spouse or children over 18 will be taxed at their marginal rates, with full tax-free threshold (but not to minors) September 2024 FNCE20003 Lecture 9 38  Testamentary trusts testamentary trusts (TT) can be used to provide: – for minors and/or family member with disabilities – asset protection for intended beneficiaries – maintenance of social security benefits – taxation benefits, particularly generation of ‘excepted income’ (minor beneficiaries) these beneficiaries pay tax on income received from a trust at adult MTRs income splitting between the surviving spouse and children is possible technically, TTs can be set up as beneficiary trusts, superannuation proceeds trusts, restricted trusts and discretionary life interests September 2024 FNCE20003 Lecture 9 39  Testamentary trusts – example 1 If distributed to son on highest 47% tax on income, MTR (i.e. he has other income): i.e. $21,150 tax $800,000 legacy generating $45,000 income p.a. Left under a testamentary trust to son $18,200 threshold for each child who has 3 children ($15,000 each) under TT arrangement, i.e. no tax September 2024 FNCE20003 Lecture 9 40  Testamentary trusts – example 2 Jack Smith had two adult children, Claire (no TT) & Andrew (TT) and his will leaves $200,000 to each of them Claire: After tax income from legacy: ⚫ married with 2 children, earns Income $12,000 $95,000 pa Tax paid (4,440) ⚫ receives $200,000 cash Net income $7,560 ⚫ invested at 6% pa ⚫ earns the interest income ($12,000) in her own name ⚫ pays tax at her MRT (30%) September 2024 FNCE20003 Lecture 9 41  Testamentary trusts – example 2 Andrew: After tax income from legacy ⚫ has 2 children, is divorced, and Jess earns $80,000 pa Income $6,000 ⚫ he receives the $200,000 in a Tax paid 0 discretionary testamentary trust Net income $6,000 ⚫ Andrew and his 2 children are beneficiaries of the trust Tom ⚫ invested at 6% Income $6,000 ⚫ income is distributed to his Tax paid 0 children, Jess and Tom, and tax is Net income $6,000 payable at adult rates Total net income $12,000 September 2024 FNCE20003 Lecture 9 42  Avoiding the pitfalls of TTs it is important to understand that TTs are not always the best solution for every client – the manner in which they are drafted can significantly impact upon how they operate, as they need to be able to deal with future events – poorly drafted trusts in inappropriate circumstances can at best be a nuisance and at worst can lead to outcomes that greatly devalue an inheritance a discretionary trust can long outlive the client (maximum life span of 80 years) control of the trust and its assets must therefore be carefully considered when drawing it up September 2024 FNCE20003 Lecture 9 43  SMSFs and estate planning SMSF trust deeds typically allow members to transfer accumulated benefits on death, thus bypassing probate, etc. on such benefits transfer of benefits can be accomplished by: – trustee directive (e.g. Binding Death Nominations, BDN) – forfeiture into the fund’s reserves important: we have seen that bequests made to dependents via wills can be challenged on the basis of ‘not making adequate provision’; however, SMSF trustee directives with current BDNs are very strong and not usually overruled – it is a way of protecting against a will or estate challenge September 2024 FNCE20003 Lecture 9 44  SMSFs and estate planning it’s important to note that the provisions of the SMSF trust deed will take precedence over any instructions given in a will that is, creating a will and automatically expecting it to be a binding authorisation of where super benefits are to be paid might not work – there have been several unwanted outcomes (e.g. Conti and Katz cases) on the other hand, since super benefits are non-estate assets, they are protected from estate (and will) challenges to take advantage of this, the SMSF trust deed should always reflect what you want to achieve, e.g. do you want to pay a lump sum of assets, or provide for an income stream? September 2024 FNCE20003 Lecture 9 45  Estate planning and FPs the key tools for effective estate planning include wills, PoAs, SMSFs, BFAs, trusts, and insurance, including life insurance policies (covered later) consistent with the theme of this subject, it is clearly of importance that FPs are aware of the nature and applicability of each of these items, as part of the “know your product” rule for example, FPs must be aware that wills can be challenged, but disposals of superannuation assets cannot be challenged, so are highly flexible and tax- effective, especially when dependents are involved – this can have an impact on the nature of financial advice provided September 2024 FNCE20003 Lecture 9 46  Summary – estate planning one reason why estate planning is not black and white is that it relates to people’s lives, their changing circumstances, and in some cases, their eligibility for death benefits or even to take on the role of a trustee the following checklist may assist in effective estate planning: – check trust deeds, and have them updated when your circumstances, or those of family members, begin to change – have a current will and adjust, if necessary, for changing family or other situations so that it properly reflects your wishes – select trustees / PoA carefully – recognise the time and costs involved in various structures September 2024 FNCE20003 Lecture 9 47  Summary – estate planning – be clear on your wealth generation objectives for after you die – determine what type of income streams, under what asset structures, you want for living beneficiaries – have a clear strategy for super and non-super assets – ensure any death benefit nominations are properly structured and documented, taking tax and legal issues into account – consider complementary vehicles alongside SMSFs that may help with estate planning, such as trusts or other specialist retirement products/advice – ensure your lawyer, accountant and other SMSF advisers prepare and hold complete and signed documentation September 2024 FNCE20003 Lecture 9 48