The best ways to structure and pass on your wealth

AFR – Wednesday, 4 Nov 2020 – Page 24

There’s been a lot of talk in recent years about the ‘‘ SKI’ ’ phenomenon (spending the kids’ inheritance) but there are many Australians who want to help their children financially – either now or in the future – passing on the wealth they built in their lifetime.

A common option in the past was to base investment strategies on accumulating within superannuation funds (specifically self-managed super funds) to access the attractive tax benefits . This approach has become increasingly difficult after the government’s introduction of strict caps on how much can be contributed to super.

Further, the limits on the types of investments that can be made, on accessing benefits , and the need to wind up the fund upon death, has made super less attractive as a way of structuring wealth.

What are the options for families looking to manage their money in a tax-effective way, to pass that wealth on to their children and grandchildren?

Some of the most popular structures have been family trusts and investment companies. They each have pros and cons; in some cases it makes sense to use both. They are more flexible than super, and worth considering when large sums (say, $1 million-plus ) are to be invested. It is worthwhile getting the structure correct upfront, as reorganising investments later can be costly in terms of fees and tax.

Generally an investment company is better suited when distributing the earnings of an investment portfolio among family members is no longer tax effective, so the size of the investment portfolio is key. Other considerations include:

Tax: Family trusts are typically not taxed themselves; instead, taxable income is allocated among family members and can be decided on year by year. This is useful for using up lower tax thresholds of family members, but may be a problem for big portfolios that generate a lot of income, which may be taxed at the highest individual marginal tax rate.

Capital gains can be distributed to anyone who qualifies for the 50 per cent discount, limiting the tax payable.

Investment companies, on the other hand, pay their own tax, usually at a flat 30 per cent. They can have different share categories, meaning dividends can be paid tax-effectively to recipients on lower tax rates. Investment companies don’t have to distribute income each year and can instead accumulate and reinvest wealth.

When it comes to capital gains, they don’t qualify for a discount and the full company tax rate is paid, but it is only incurred when an asset is actually sold.

Access: A key issue with superannuation is the funds can only be accessed on retirement. Both family trusts and investment companies offer much greater access, but there are still some issues to consider.

Distributions can be loaned back to a family trust by beneficiaries for reinvestment.

But, this creates a liability for the trust to pay that individual at some point. In addition, loans to the trust can be recalled.

Another benefit is that loans can be obtained from a trust with no tax consequences, which can be useful.

Similarly, with investment companies, dividends paid out can be loaned back to the company, or not declared in the first place and, like family trusts, loans to the company can be recalled.

However loans from the company are problematic – they can be treated as unfranked dividends, or subject to interest and repayment rules.

Estate planning: Both family trusts and investment companies are much more suited to estate planning than superannuation.

With family trusts, when a trustee dies a new trustee will need to be appointed, but otherwise the trust can continue uninterrupted, although family trusts typically have a lifespan of 80 years. Likewise, new directors of an investment company will need to be appointed upon death of an existing director, and the shares in the company can be simply passed on or bequeathed to beneficiaries .

It’s also very tax-effective , as there is no tax payable at this point, and the company can continue indefinitely .

Asset protection: This is one area where superannuation is very effective as a complying fund is treated as exempt property when it comes to the bankruptcy of a member.

The terms of the deed of the family trust will be important in dictating the level of asset protection provided, but there is the opportunity to provide some degree of protection.

Investment companies also offer some asset protection through their status as a limited liability company.

Compliance costs: Both family trusts and investment companies need to have tax returns and accounts prepared each year. But there is no need for an audit as there is with SMSFs.

Michael Hutton is wealth management partner at HLB Mann Judd Sydney.

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