CPD: Estate planning – where there’s a Will there’s a way

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The Will, Powers of Attorney, and Testamentary Trusts form a key role in estate planning.

Often, when people think of estate planning, they focus on the consequences following death. As a result, they often do not appreciate that there are many documents which need to be properly drafted as part of their estate planning. Of those, the Will is a key document, along with Powers of Attorney, and Testamentary Trusts. In this article Zurich will examine each of these documents and explain their role in estate planning.

A Will provides guidance on what is to happen with a person’s assets (their ‘estate’) and indicates who will be responsible for overseeing the terms of their Will and carrying out those wishes. Many people think this is the start and end of their estate plan; a current Will to disburse their estate. While it is an integral part of an estate plan, it’s just one of three key documents that might be necessary.

The Will

A properly drawn Will can:

  • be a powerful tax-planning tool
  • provide a flexibility of options to enable maximum benefit passing to beneficiaries
  • address the ‘what ifs’.

There are various legal requirements that must be met for a Will to be valid and effective; a properly drawn will is crucial so your clients can make appropriate, informed choices.

A Will has no legal effect until death; it’s the last, valid Will which is given legal effect. Consequently, it’s important that any modifications are made carefully, with appropriate recognition of all the circumstances of the Will-maker. It’s also important that the Will be properly stored and easily locatable upon death of a person.

The Estate

Only the assets that were owned by the deceased at the time of death form part of the deceased estate. People often overlook this very important requirement. For example they may run a business that is owned by a company or trust and treat the assets of the business as their own. Their Will cannot dictate what will happen to the assets of that business, however the ultimate holding of shares and/or units will be a critical part of any estate plan.

This is why it is so important to review all of a client’s affairs and related interests when assisting them to design their estate plan. 

Assets not disposed of by a Will

Property owned by a company, a trust or as joint tenants cannot be disposed of by a Will.

There are some assets that a person may have an interest in but might not be able to dispose of in their Will. These assets include:

  • superannuation proceeds (recent changes to superannuation law now permit a binding nomination whereby proceeds can be directed to the estate and trustee discretion will not apply
  • life insurance policy proceeds.

Probate

Probate is an order made by the Supreme Court and declares to the world that a Will is valid, and its terms may be put into action.

Unless interim relief is ordered, it is only after probate is granted that the executor has the legal power to administer the estate. Assets in the estate are usually ‘frozen’ until probate is granted. This can cause problems if another person, such as a spouse, relied solely on the deceased for financial support and has no other source of income.

Making a valid Will

There are a number of legal requirements which must be followed in order for a Will to be valid. They relate to capacity and to signing.

In general a person must be at least 18 years old and of sound mind in order to have legal capacity, although some States allow certain exceptions. For example a person in the Armed Forces who is under 18 may be considered to have legal capacity.

The legal requirements regarding signing are:

  • the Will-Maker must sign the Will
  • there must be two adult witnesses
  • the two witnesses must be present at the time that the Will-Maker signs and each of the witnesses sign
  • the witnesses must sign the Will as required while the Will-Maker is present
  • the witness must NOT be a beneficiary or married to a beneficiary (otherwise the benefit will be void).

Review – when to make a new Will

Whenever there is a change in the personal circumstances of a client they should review their Will and, where appropriate, make a new one.

Scenarios that might trigger the need for a new Will include:

  • separation from spouse
  • commencing a new relationship
  • birth of children or grandchildren
  • marriage of children or grandchildren
  • death of a proposed executor, or proposed testamentary guardian
  • death of a major beneficiary
  • change of assets, particularly those which are ‘earmarked’ for a particular beneficiary
  • inheriting a windfall (i.e. having more assets to bequeath).

Tax Liability

Because the executor represents the estate they are personally liable for any tax liability of the estate. This liability becomes important if the estate does not pay the tax required by law. In those circumstances the executor must pay it out of their own personal funds.

To protect against such a situation an executor should:

  • obtain appropriate advice early in the administration;
  • actually pay the tax bill out of the estate; or
  • retain a sufficient amount in the estate to pay any future tax liability, before paying out the balance to the beneficiaries.

Dying without a Will

A person who dies without a valid Will is said to have died intestate. Each state and territory has its own specific intestacy rules, which include who may be entitled to the deceased assets and how much they may be entitled to receive.

In many jurisdictions, assets are generally distributed according to a predetermined formula with certain family members receiving a defined percentage of the assets. This will typically depend upon whether the deceased had a spouse and/or issue (e.g. children or other descendants).

Powers of Attorney

A Power of Attorney is a document which has legal effect. It allows one person to act on behalf of another, generally in relation to financial or property decisions. A Power of Attorney ceases to be effective once the person who has made it dies.

A Power of Attorney is an important tool in the event that a client loses the mental capacity (legal capacity) to manage their own affairs, such as through injury or illness.

In general there are two types of Powers of Attorney:

  • General Power of Attorney – provides that the attorney has all the legal powers and capacity as the Grantor. These are generally used for commercial or transactional purposes to conduct, for example, a sale or purchase of property.
  • Enduring Power of Attorney – important for estate planning purposes, as it allows the attorney to act on the behalf of the Grantor in the event that the Grantor loses mental capacity.

These appointments can help a client plan for a future in which they have lost the power to make rational decisions.

Granting a Power of Attorney

The legal effect of a Power of Attorney is dictated by legislation. The legislation specifies various requirements that must be met before a Power of Attorney is given effect.

If the requirements are not followed the Power of Attorney will not be effective. Those requirements deal with the following:

  • Type – whether the Power of Attorney is general or enduring or both, reference to the relevant legislation must be included in the document
  • Capacity – both the Grantor and the attorney must be adults, of sound mind and with legal capacity (e.g. not bankrupt)
  • Signing – the signature of the Grantor must be witnessed by someone specified in the legislation. Those witnesses may include a barrister, solicitor or other person prescribed by the Regulations (the particular categories depend on which State the Grantor is signing the document). The person named as the attorney must not be the witness
  • Form – the legislation specifies the particular form which the document must take
  • Registration – in some states the document may need to be registered with a Government authority
  • The fact that a Power of Attorney is given legal effect by State legislation means that a client with assets in different States may need to make more than one Power of Attorney.

Testamentary Trust

A Testamentary Trust is a discretionary family trust established under the terms of a will. The assets that form part of the estate will be held in trust for a potential beneficiary until the termination of the trust (for example, in the event the beneficiary reaches a nominated age).

There are four key roles in a Testamentary Trust:

  1. The Trustee/s, which see to the administration of the testamentary trust assets in accordance with the stipulated terms and within the powers afforded to them.
  2. The Principal, who can remove/replace the Trustee if and when required. This could, example, arise if the Principal believes that the Trustee is not administering the Trust in accordance with their powers or in accordance with your clients’ wishes.
  3. The Alternative Principal, a person the Will Maker nominates to act in the role of the Principal if the Principal were to be removed from that role. The most common scenarios where this happens is if the Principal resigns from their role or passes away.
  4. The beneficiaries, individuals, groups or entities are entitled to receive a distribution of the income and/or capital of the testamentary trust assets, made at the discretion of the Trustee.

Benefits

The key feature of a Testamentary Trust is that while the assets remain in the trust, no particular beneficiary has any right to claim ownership of those assets. The various results which can be achieved by using a testamentary trust include:

  • Certainty that a particular beneficiary will receive some income from the estate
  • Certainty as to when the beneficiaries will receive their inheritance
  • Protection, or preservation, of social security entitlements of a beneficiary
  • Protection of certain assets from the claims of creditors
  • Possible protection of inheritance in the event of the divorce of a beneficiary
  • Tax effective income splitting
  • Deferral of capital gains tax.

Certainty of income for a beneficiary

The use of a testamentary trust can include features which ensure a particular beneficiary will receive adequate income from the estate.

A less satisfactory method sometimes used is to grant a “life interest” in the assets of the estate to that beneficiary. The “life interest” approach does not have the same flexibility and can create significant capital gains tax problems.

Control over timing of inheritance

A properly drawn Testamentary Trust can give the Will-Maker control over the time at which a beneficiary is to receive their inheritance. For example the Will-Maker may be concerned that one of the future beneficiaries is a ‘spendthrift’. It is important to appreciate that, without proper planning, once a beneficiary is an adult (i.e. they turn 18 years of age and are of sound mind) that beneficiary may be entitled to insist on their inheritance being given to them. Many clients consider that their children would not be responsible enough to handle their inheritance at the age of 18.

In some cases a Testamentary Trust is created to provide for a particular purpose, such as funding the educational expenses of dependent children.

Tax

A discretionary trust provides flexibility in distributing income. This can provide useful, legitimate tax effectiveness in relation to the income of the trust.

There is an added advantage with Testamentary Trusts, when young children are included as beneficiaries; the tax legislation treats infant children as adults for tax purposes. This means that the income received by an infant child may be taxed at the same marginal rates which apply to adults. They may also receive the benefit of the adult tax-free threshold.

This is what makes a Testamentary Trust such a powerful income splitting and tax planning tool, as part of a client’s estate planning.

Maximum tax planning advantages can be provided by a Testamentary Trust for:

  • spouses, or adult children, who are not working
  • children who are under 18 and not working
  • grandchildren who are under 18
  • nieces/nephews who are under 18.

The best approach with this aspect of estate planning is to consider the results which the client wishes to achieve, in relation to younger, or future, generations.

Testamentary Trusts and capital gains tax

Generally, assets transferred via an estate are not subject to capital gains tax (CGT) though there can be situations where CGT may apply (e.g. a charity or foreign resident as beneficiary).

CGT liability is triggered when the assets are later disposed of. A Testamentary Trust may be used to defer any capital gains tax liability. Subject to general tax principles, this deferral could pass across a number of generations.

Improving the financial outlook for the family is the key driver for the majority of Australians – yet so many fail to fortify that legacy through estate planning. Although the documents discussed in this article are generally prepared by legal professionals, financial advisers are best placed to direct the process given the intimate knowledge they possess about their clients financial and personal affairs.

Estate planning is an opportunity to add significant value to both your client relationships and your business. An adviser that can help their client manage family complexities will build deeper client relationships as evidenced by higher client satisfaction and referrals rate.

 

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A quick glossary

  • The testator is the person who makes the will. The female is known as the testatrix. In this article, the term “will-maker” is used.
  • The estate is the term used to mean the net assets (wherever located) owned by the deceased when they died.
  • The executor is the person (nominated in a person’s will) who is legally responsible for administering the deceased’s estate in accordance with the terms of the will (carrying out their wishes, legally).
  • A beneficiary is any person (individual or otherwise) who receives a benefit under the will.
  • A codicil is a document executed as a will which amends an existing will (but only in part).
  • A person who dies without a will is said to die intestate. Where no valid will is in place, the laws of intestacy regulate how the net assets of the estate will be distributed.
  • A testamentary guardian – is a person nominated in a will to act as a ‘parent’ for infant children of the deceased.

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