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Estate Planning

Estate Planning and Family Trusts

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Estate Planning and Family Trusts – what are the issues?

What even is a family trust? When people talk about a family trust they are generally talking about a discretionary trust; a discretionary trust is a trust where the trustee has discretion over (they can choose what to do with) some or all of the income and assets of the trust. Really this type of trust is better called a discretionary trust or non-fixed trust as the rights to the income and assets of the trust are not fixed.

The words “family trust” relates to making a family trust election with the Australian Tax Office which is a taxation concept which is a topic for a different article.

If you are the trustee of your family trust or director of the trustee company then you could replace yourself on death by leaving a point in your will that XYZ is the new trustee. I have seen this done and also often recommended by accountants to clients when setting up their new family trust and while this may be possible it is often not.

Replacing a trustee is often controlled by a person called an appointor so irrespective of your wishes (as set out in your will) if your trust has an appointer then that appointor can appoint whoever they want as trustee. In the event the appointor is not available or your trust does not have an appointor then your trust deed may set out steps that need to be taken to replace the trustee – these will need to be followed.

I have also heard from clients that “put your assets in a family trust, then they can be passed on to your heirs and their heirs without paying any tax on death” There are a couple of points that I think are important to look at with this

  1. Rule against perpetuities – the laws within Australia prohibit perpetuities – in other words a family trust cannot exist indefinitely, typically the lifespan of a trust is limited to 80 years.
  2. On death you will generally pay capital gains tax (CGT) on any assets sold as part of the administration of your estate but you do not need to sell your assets on death and there are a couple of ways to avoid paying this CGT.

You can transfer Assets directly to your heirs in this case the asset keeps the original cost price from when you bought it and your heir can keep the asset indefinitely and even leave the asset to their heirs paying no tax at the time of your death. (but paying tax if and when they sell)

On death another option would be to create a testamentary trust for example by saying “I leave my rental property on trust with the rent to be enjoyed by my son and the house to be left to my grandchildren do do as they wish when my Son dies” there are a lot of potential benefits to using a testamentary trust including tax benefits and other benefits but their use and what terms you include depend on your situation.

This article is quite general buy hopefully you can see that trusts can be quite complex when it comes to your Estate plan; your Will and other plans. Please consider consulting a professional who has experience working with trusts when planning what will happen with your Estate. You can contact us here.

News

Tax Assured & Justified Trust

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What is Tax Assured and the ATO’s justified trust program? The ATO’s Justified trust program comes originally from work done by the OECD and now implemented in Australia (and other OECD countries). Some background; in Australian we have what is called a self assessment system where we (taxpayers) work out our taxable income and send it to the Tax Office who issues an Assessment assessing the tax payable. All things being equal the ATO accepts that the numbers supplied are correct, having to conduct an audit if they suspect wrong doing.

The Justified Trust Program seeks to change this by performing what is basically an Audit of taxpayers each year in enough details that they consider that the tax position is assured or correct. Initially the Justified Trust program only applied to the top 100 Companies in Australia, it was very successful at both collecting more tax as well as lifting confidence in tax assessments so the program has now been expanded to the “next 5000” as well as private wealthy groups. The approach and regularity in these different groups varies but is underpinned by the same concepts and goals. What can you do to understand this and lower your risk?

  • The vast majority of groups are actively participating in the Justified Trust and Next 5000 programs but there are some groups who are refusing. I suggest it is in your interest to work with the Tax Office, while it is an increased burden to engage with the Tax Office it does also give you peace of mind that in the future you will not have a retrospective audit as you have already disclosed any major transactions.
  • Risks Marked to Market: There is some mis understanding of this key part of the program; once you are a TaxPayer who is large enough to be included in these programs the ATO expects you to review ATO rulings, TaxPayer alerts and Practical Compliance Guidance. This is a key way the Tax Office notifies tax payers of risk they see.
  • Keep neat records, lodge and pay on time. Seems simple but it is not always easy to achieve, late lodgement and/or payment increases the Risk rating the tax office applies to taxpayers (of all types and sizes!)

Author Alan Maddick May 11th 2022.

News

Trust Tax Expert

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Welcome to Maddick Consulting Group, my name is Alan Maddick and I am the owner of the business. Over the years I have developed a love of tax and the laws that rule our complicated tax system. Throughout the system there is a lot of wrong information; nowhere is this more common than the area of trusts, an area I specialise in. Most Accountants and ATO staff do not have a strong understanding of the laws the underpin trust taxation, areas I can help with;

  • Unit and Investment trusts
  • Deceased estates (these are also a type of trust)
  • Minor trusts
  • Disability trusts
  • Testamentary trusts
  • Family trusts
  • Self Managed Super (these are also a type of trust)

I can explain how these trusts work and how they interrelate with your Investments and your Personal Tax position. If you need help with your trust tax issue or a second opinion please get in touch with us here

Downsizing, Income Strategies

Case Study: Maximising Income in Retirement

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Case Study: Maximising Income in Retirement – please remember this is an example of advice given – your financial situation may be different so please get advice before you act.

This is a recent client file, we have changed the name and some numbers are rounded for simplicity. This is a real world example of a common advice situation we deal with.

Background:

Betty is single and is 74, she owns her home (a two bedroom unit worth around  $600,000) and has $550,000 in super. Apart from that she has typical house and contents and a car worth around $10,000. In my experience and these numbers I would consider Betty a fairly well off retiree who will be quite comfortable in retirement.

Despite this in our meeting she discusses how broke she is and is trying hard to cobble together part time work of around $10,000pa to help buy food and pay the bills, initially I suspect Betty is spending too much and as advisers our main area of assistance will be to work on her budget. On further investigations I discover she has set up an Account based pension in her super which is paying $920 per month ($11,040 per year) as well as this she is getting a part aged pension of $103.50 per fortnight ($2691 per year) for a total income of only $13,731 per year. (with her employment income on top of this)

This is well below the income needed for a comfortable lifestyle of $45,962 a year as reached by ASFA[1] and is well below even the “modest lifestyle” retirement standard of $29,139 a year. Surprisingly ASFA believe that to achieve a comfortable lifestyle you will need a super balance of $545,000, slightly less than Betty has so what is going wrong here?

Betty says she does not want to draw a larger pension from her super or she will run out of money and/or the income she will generate will get even less as she eats into her super lump sum and with the assistance of a friend has worked out this pension amount is satisfactory for her budget and to not diminish her super balance. In my experience this sort of thinking is common, we live our whole life building super, saving and looking at an increasing netwealth as a sign of success. It can be quite hard to change your mindset in retirement to focus on making your assets work for you and actually living off them.

After further meetings and discussions we moved $275,000 of Betty’s super to a lifetime annuity which paid an annual income of $15,038 in year one. This is adjusted up each year by inflation and guaranteed for life. If betty dies early then her estate will get some or all of the $275,00 back but if she lives a long healthy life then the investment will be worth nothing when she dies.

Because only 60% of the Annuity’s value counts for the Pension Asset and Income test Betty’s pension goes up to $384 per fortnight straight away and over the first 5 years Betty will receive $27,241 in extra pension payments as a result of buying the annuity.

(please note the $275,000 is not a magic number for Betty or for you, this is a number reached by working through Betty’s goals, funds she wants left in super for emergency etc)

We also adjusted Betty’s super investments and pension setting so that it can pay the remainder of the $45,962 needed for a comfortable lifestyle (so in year one it will pay $19,517) this does mean her super balance will reduce each year but with even modest investment earnings her super will still last until she is around 110 years old! Remembering too that she does not need to draw the full $19,517 we recommend. Many clients have a very large phycological block to depleting their assets in this way but you have to remember your super is there for you to retire! If Betty lives to her typical life expectancy she will still actually have around 100% of her investible assets available and will have her home as well to pass onto her Children and after our advice she is now comfortable that her money will not run out before she dies. This was a major fear of hers and is with many clients in this stage of life.

As part of our advice we researched the best Annuity product for Betty which was substantially better than any competitor product and helped her select terms that suited her situation. We did not accept any product commissions either initially or on an ongoing basis, from this product.

We also worked with Betty’s existing super fund to generate more income and investment return, because we do not accept commissions or percentage based fees from client’s super funds we can work with any fund, rather than forcing clients into our preferred product. In this case Betty was happy with her fund and it is a high quality Industry fund so there is no reason to replace it. This also minimises disruption for Betty.

Our fees for the advice were $3150 including a number of meetings, written advice and assistance in putting the new financial product and strategies in place. This charge was based on the hours spent on the file throughout the advice process.

If you would like to review your retirement income strategy then please contact us here.

[1] https://www.superannuation.asn.au/resources/retirement-standard

News

Life Insurance Commissions

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Alan Maddick, March 2022

Traditionally when Financial Advisers recommend and advise on Life Insurances like Income Protection, Trauma or Life Insurance they receive a commission from the Life Insurance company; both initially on placement of the Insurance as well as on an ongoing basis.

Financial Advisers will say a couple of common things;

  1. “Commissions are paid by all insurers so it does not create a Bias or Ethical dilemma” or
  2. “The commission are paid from the insurer so there is no cost to you”

Lets have a look at number 1 – the commissions on insurance are generous and do create issues in the advice given by advisers, so much so that the Government has taken action to reduce the amount of commission payable reducing it down from 110% of the year 1 premium to now 60% of the year one premium. You can read more about this here on the ASIC site: Life Insurance Framework

For example a $1000 insurance premium will pay a $600 commission, if an adviser encourages you to take out more insurance lets say a $3000 policy now they are getting paid $1800 instead of $600. This creates a bias and business model where advisers will be rewarded for selling as much insurance as possible. If you need more insurance this is great news but if those extra funds could instead have been paid off your home loan or contributed to super then it is not so great for your long term financial position.

Next the commissions that are paid from insurers are paid from the premiums you pay! So the cost of the commissions do increase the cost of insurance. In fact this is so clear that as an adviser I can elect not to take a commission with most insurers. By doing this the Insurance Premium will be reduced by around 25%,* going back to the $3000 per year insurance example above by me not taking a commission that would reduce your premium to $2250 per year, a saving of $750. Imagine you keep the insurance for 15 years, you would save $11,250 or more.

As an adviser there is an issue with not getting paid for my work via commissions and that is I still need to get paid for my work advising you. Without commissions paying me you will need to pay for advice; while this is an out of pocket cost you can see it can save you a substantial amount. If that does not suit you I am happy to discuss receiving some commissions to cover part or all of the cost of advice.

* (some variation in the discount between insurers and policy types)

Estate Planning

The Last Innings

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As we near the end of life many people’s mind’s naturally turn to tidying up their affairs, this often includes things like making sure they have an up to date will and have appointed a Power of Attorney. Perhaps even putting in place some medical care instructions or Funeral plans.

These are all wise things to do, at Maddick Consulting Group we deal with deceased estates quite often and we see some common issues that are not picked up at this stage.

  • If you have super towards the end of your life you may want to consider cashing your super completely. Perhaps even leaving this instruction to your Power of Attorney(ies), the reason is if your super is paid to a non dependant (like your adult children) they will generally pay tax on this. Where generally if the super is cashed out as long as you have met a condition of release you will pay not tax and the funds will then form part of your Estate with no tax payable.
  • Appointing an inappropriate executor to your estate. Some executors are not appropriate; for example anyone who does not live in Australia will have trouble administering your estate, there could also be some adverse tax consequences for your beneficiaries. Another common issue we see is executors that are not good at administration and paperwork…this role of executor is primarily a role of paper work!

Please note the aim of this article is just to highlight a couple of issues we see regularly in our work, please consider your position and get professional advice before acting.

News

Sandringham tax

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Welcome to Maddick Consulting Group, we are Tax Specialists and happy to help you with your Tax Problem. We are located in Bay Road Sandringham / Cheltenham.

We prepare tax returns for all entity types with special interests in Private Wealth, Trusts and Estate Tax. Alan Maddick the Practice Owner has worked in Tax for a number of years and has supervised the lodgement of literally tens of thousands of tax returns. There is a wide range of opinions about what the Tax Laws say; our aim is to explain what the law actually says, not what Joe from the Pub told Paul who told you. Sadly this is also how some Accountants get their tax knowledge!

Alan the practice owner grew up locally and attended Hampton Primary and Sandringham Secondary College just down the road. If you want some help with your tax work please get in touch with our Tax Experts here

Estate Planning

Life Insurance and Estate Planning when you are Divorced

Warning: This content has been prepared without taking account of your personal objectives, financial situation or needs. Before you make any decision regarding any information, strategies or products mentioned in this newsletter, consider whether it is appropriate to your own objectives, financial situation and needs.

Setting up your Estate Plan when you have divorced is very important, in this article I will look at a common situation.

(this is a made up example): Bob has one child Kim from his first marriage to Cathy. He has now married Sharon and they have a new child Paul.

Sharon and Bob have a house with a mortgage; Bob also has super of 200k.

Bob wants to make sure if something was to happen to him that Sharon and Paul would be provided for as Paul is only 2 and Sharon is not working at the moment; but he also wants to make sure that Kim is provided for and that Cathy can not claim any part of his estate.

Presuming the house they have bought is in Joint Names then if Bob was to die this house will not form part of his estate; it will transfer over to Sharon. Because it is not part of his estate no one can attempt to claim part of it (for example Kim or Cathy). But this also means that Bob cannot leave part of the home to Kim if he wanted to.

With Bob’s super he has two choices he can do nothing in which case his super may be paid to his current wife Sharon or be paid out to his estate (the Super Fund trustee would decide the most appropriate treatment) this could also be open to dispute. Or he can make a binding nomination; in this case Bob’s super payment will be paid to the person or people that Bob nominates. As long as the Binding Nomination is correctly executed this nomination is not open to dispute after Bob dies.

From a tax Point of view payment of a death benefit from super to a “super dependant” such as a current spouse or under 18 child will be tax free.

Essentially Bob has 3 people he potentially wants and needs to provide for; His Daughter Kim, current wife Sharon and their Son Paul. As long as Bob trusts Sharon to look after Paul he can provide financially to Sharon only as Paul is still too young to look after his own finances. While potentially you can have one life insurance policy that provides for all three people (or more) or you can also make a super nomination nominating three people. To minimise the possibility of dispute and make things very clear I would recommend that Bob takes out a life insurance policy outside of super to specifically provide for Kim. Depending on Kim’s age he may want to allow for a testamentary trust to preserve the proceeds from the life insurance for Kim until she is old enough to look after the funds herself.

To provide for Sharon and Paul Bob can leave his super via a binding death benefit nomination. This reduces the ability for Cathy to dispute his will on behalf of Kim. If Bob wants to provide more than the $200,000 super balance, then he can take out a second life insurance policy. This could be held by his super fund (and so paid out in line with the binding death benefit nomination) or outside with the policy owned by Sharon.

Downsizing

Aged Care Advice

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At Maddick Consulting Group we are expert at providing Aged Care Advice and can help you through this time. Initially our advice is normally advice and explanation of Aged Care fees, what they are and how they are calculated. Initially it’s important to understand what is a RAD (Refundable Accommodation Deposit) and how it differed from DAP (Daily Accommodation Payment), either a RAD or DAP is the first fee you pay in Aged Care.

At the moment refundable deposits are generally around $450,000 but can be $700,000 or more, you will get your deposit back in full if you need to move to a different aged care facility or they will be paid out to your estate so you do not need to worry about losing these funds. If you do not pay a refundable deposit then you will need to pay a Daily Accommodation Payment on an ongoing basis, this will generally be quite expensive and is not refunded. It is generally not ideal to pay daily accommodation payments.

On top of the RAD or DAP you will have to pay aged care fees, there are two levels of care fees, a basic fee that every pays. This is 85 % of the basic aged pension, so if eligible for the pension then this will cover these fees. On top of the basic fee there is an additional income tested fee that you may have to pay depending on your level of assets and income.

Confusingly the Aged Care means test and the Aged Pension Income and Assets tests are different and calculated quite a different way.

After our initial advice and assistance understanding aged care fees we can also advice on financial strategies such as;

  • Structuring your affairs so that you can claim the full pension
  • Minimising means tested care fees
  • Investing your surplus assets to generate returns to help pay aged care costs
  • Advice and structuring financial affairs for the remaining spouse so that they can still afford to live outside aged care

When discussing aged care we generally charge a consult fee of $275 inc GST, in this first session we will get to know you and what is happening. We can also advise on the basics of aged care and start looking at how aged care fees will apply in your situation. Any additional work will be quoted before we commence.

Please get in contact with us HERE

Downsizing

Reverse Mortgage v equity release

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Reverse Mortgage v Equity Release

Author Alan Maddick 19th December 2021

Contact alan@accountantmm.com.au you can download a PDF version of this article here.

When clients ask me “how much do I need to retire?” or “what should my goals be” I always say the first thing you need is to own you home with no mortgage. There are a couple of reasons for this;

  1. If you own your home then you have no mortgage or rent cost to pay in retirement. Rent or Mortgage would be one of the largest expenses for most households so cutting this out improves retirement.
  2. Capital preservation. In Australia most Real Estate goes up in value well above inflation so the money tied up in your home is increasing, this increase and the underlying asset do not form part of the pension asset or income tests and any gain is tax free. This can allow you to make money early in your retirement while giving you options later in life for example if you need aged care or another unexpected event occurs.

Sometimes clients will use a Reverse Mortgage or Equity release early in retirement to “Pay off their Mortgage” This is not what you are doing as you will be just replacing one debt with a different type of debt. Let’s have a look at what these products are:

Reverse mortgage

A reverse mortgage allows you to borrow money using the equity in your home as security.

If you’re age 60, the most you can borrow is likely to be 15–20% of the value of your home. As a guide, add 1% for each year over 60. So, at 65, the most you can borrow will be about 20–25%. The minimum you can borrow varies, but is typically about $10,000.

Depending on your age and lender policy, you can take the amount you borrow as a:

  • regular income stream
  • line of credit
  • lump sum, or
  • combination of these

How a reverse mortgage works

You stay in your home and don’t have to make repayments while living there. Interest charged on the loan compounds over time, so it gets bigger and adds to the amount you borrow. The interest rate is likely to be higher than on a standard home loan.

You repay the loan in full, including interest and fees, when you or your deceased estate sell your home.[1]

Equity release / Sale Proceeds Sharing

Equity Release, Home sale proceeds sharing, or home reversion are all names for more or less the same thing. Terms can vary depending on the provider and agreement but in short they allow you to sell a proportion (a ‘share’ or ‘transfer’) of the future value of your home while you live there. You get a lump sum, and keep the remaining proportion of your home equity.

How home sale proceeds sharing works

The provider pays you a reduced (‘discounted’) amount for the share you sell. How much you get for the share depends on your age. Terms and conditions vary. The provider may offer a ‘rebate’ feature. This means you (or your estate) get some money back if you sell your home (or die) earlier than expected. The amount you get back depends on when you sell your home and how much you got for your sold share. You may also have the option to buy back the sold share later, if you wish.

For example, suppose your home is currently worth $500,000 and you sell a 20% share of the future value. Depending on your age, the provider may offer you $37,000 to $78,000 to buy that share today. When you sell your home, the provider receives their share of the proceeds. Say in 20 years time you sell your home for $800,000. The provider gets 20% of the sale price ($160,000), minus any rebate (if applicable).[2]

What home sale proceeds sharing costs

It’s not a loan, so you don’t pay interest, this appeals to many clients. You will typically pay a fee for the transaction but the real cost is the difference between what you get for the share of your home you sell now, and what it’s worth in the future (minus any early sale rebate) The more your home goes up in value, the more the provider will receive when you sell it.

So what is the best option?

When Capital growth is low then equity release will often turn out to be quite attractive but the opposite is also true; in periods of rapid capital growth (like now!) clients are often shocked how much they end up paying under an equity release scheme.

Equity release also generally works out well when the time from taking out the loan to the eventual sale of the property is long as interest doe not build up or accrue over time. 

There are other options

Often equity release and/or reverse mortgages are portrayed as the only or best option if you get caught in a situation where you have a lot of equity in your home but need funds for your lifestyle of even to pay out the last portion of your home loan when you retire. Depending on your situation there are a range of other options that may work for you for example;

  • Selling other assets
  • Withdrawing a lump sum of pension from Super
  • The government pension loan scheme

In my experience in most situations where a Reverse Mortgage or Equity Release is considered clients are better to sell their home; free up the capital they need and then re-buy a new more affordable home. Of this may be smaller and lower maintenance as well which often fits with this stage of life.

When I have modelled these scenarios for clients as well as in real life situations doing this (selling and buying something smaller) preserves the most capital for clients. This allows you to pass this on to family. Some clients tell me that either they don’t care about what their kids inherit or perhaps they don’t have kids, in these cases it is still wise to preserve capital. You never know what the future holds and as long as you have capital in your home you have options, remembering your home is not counted for the Pension Asset test either.

One thing to consider when looking at the capital you are preserving is if one partner needs aged care down the track you will want to have a RAD (Aged Care deposit) at the moment this is averaging 450k.

These products are complex and I have seen many scenarios where they have caused significant harm to clients, please get professional advice before you act and remember this article is just my opinion and what is right for you will differ depending on your personal situation.

[1] MoneySmart.gov.au, Reverse mortgage and home equity release, https://moneysmart.gov.au/retirement-income/reverse-mortgage-and-home-equity-release

[2] MoneySmart.gov.au, Reverse mortgage and home equity release, https://moneysmart.gov.au/retirement-income/reverse-mortgage-and-home-equity-release