For many, leaving something behind for our loved ones after we pass is extremely important. However, tax can often take a large chunk of what the beneficiary receives if handled without care and planning.
Here’s what you need to know (whether giving or receiving an inheritance) to ensure that the gesture receives the maximum.
In Australia there is no inheritance or death tax in any of its states or territories, meaning that the net total of the deceased’s estate is left untouched under law. However, there are still tax obligations that might apply. Being aware of them helps ensure the best possible outcome.
What is a beneficiary?
A beneficiary is a person who receives all or part of the distribution from a deceased estate. It’s important to keep in mind there may be some tax obligations for any distribution you receive.
Things to consider when it comes to tax and giving or receiving an inheritance…
Super death benefits
Earning an income from the deceased’s estate
Capital gains tax (CGT)
Many people find comfort in knowing they can help their loved ones, even after they’ve passed. Estate planning is about creating a strategy for doing just that, including how you can set up your Will and other legal processes to manage any tax obligations as efficiently as possible. This allows you to ensure you’re giving your loved ones as much as possible and minimising any issues on their end.
For example, if you have any of the following, having an effective estate plan takes the stress and worry off your loved ones after you’ve passed:
A family business
Property with some capital gains
One of the most important factors in minimising the amount of potential tax involved with distributing your estate is having a valid Will. In the document, you name an executor, whose duty it is to ensure your wishes and estate are dealt with properly after you’re gone. The executor deals with any tax obligations on your side prior to administering your Will, such as filing your tax return and paying any income tax you owe.
Not only does a Will allow you to choose who inherits what, but it also provides you with the opportunity to set up a testamentary trust.
What is a testamentary trust?
A testamentary trust is a trust that comes into place when someone passes away and is created via a legal document, such as a Will. It contains specified assets as dictated by the person who holds the Will, and the nominated trustee oversees it. Depending on one’s situation and needs, more than one testamentary trust can be set up, particularly if you have more than one beneficiary.
Should you consider a testamentary trust?
Not everyone needs a testamentary trust. However, if you’re concerned about how tax may impact an inheritance you’re giving a loved one, it’s important to discuss whether a testamentary trust might help with a trusted financial advisor.
For example, it can assist in dealing with capital gains on any taxable income from the sale of property you owned.
Receiving an inheritance
While the executor handles any tax obligations on the deceased’s behalf, there are still some obligations that you may have to deal with on your end when receiving your inheritance.
Are you a dependant?
Many of the tax scenarios surrounding an inheritance change are contingent on whether Australian tax law considers you as a dependant of the deceased. This relies upon you fulfilling one of the following requirements:
You’re a surviving, or former spouse.
You’re a child of the deceased and under the age of 18.
You’re financially dependent on the deceased.
You had an interdependent relationship with the deceased.
What you need to know about superannuation and receiving super benefits
If the deceased person had superannuation, the super fund's trustee will work out whom to pay any benefit to (either as a lump sum or an income stream). Super paid after a person's death is called a 'super death benefit'.
The tax on a super death is referred to as the death benefit tax.
Death benefit tax depends on the following:
whether you were a dependant of the deceased under taxation law
whether it is paid as a lump sum or income stream
whether the super is tax-free or taxable and whether the super fund has already paid tax on the taxable component
your age and the age of the deceased person when they died (for income streams).
Not all of an individual’s assets are legally dealt with via a Will. For example, this legal document does not determine whom a superannuation death benefit is released to. Instead, it depends on the superannuation fund's trustee or the binding death benefit nomination made by the individual, if there is one.
If you are receiving the death benefit, how it is taxed depends on whether it’s paid out as a lump sum or an income stream.
1) As a lump sum:
You won’t pay tax if you’re legally considered to be a dependent.
If you’re not a dependant, you will have to pay tax on the lump sum. How much you’ll pay will depend on the taxed and untaxed elements involved with the amount you’re receiving.
2) Drawn as an income stream:
This option is only available to dependants. If you leave the money in super and receive it as an income stream it does means you’ll likely have to pay tax on it. How much depends on the age of the deceased and yourself, as well as the taxed and untaxed elements.
Inheriting property and the capital gains tax (CGT)
There is no tax if you receive property as part of an inheritance. However, if later on you sell or dispose of it you need to consider the possibility of CGT. Once more, a lot depends on whether you’re considered a tax dependent of the deceased or not.
Two ways of dealing with property that you’ve inherited that don’t involve CGT include:
Selling any inherited estates within two years of the deceased’s passing.
Choosing to use the property as your main principal residence if you’re regarded as a dependant.
Another factor to consider is whether you’re receiving any income from the deceased estate. There are a variety of factors to consider in this scenario that may impact whether you need to pay tax on the money you’re inheriting.
It’s wise to discuss how you should proceed with dealing with any property you’ve inherited with a knowledgeable financial advisor. They can assist in creating a strategic long-term plan so you can make the most out of what you’ve received.
@Paul Barrett of Absolute Wealth Advisers is one of Australia's most experienced Private Wealth Managers. He is a financial expert in high net wealth divorce, estate management, and inheritance. Contact him here