| Estate Equalisation |
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Estate equalisation is about creating wealth to offset indivisible assets through life insurance and other savings. Where an asset such as a business or an interest in a business is not easily divisible, then the provision to beneficiaries of an equivalent value of gifts may need to be considered. This may not be easily achieved where an interest in a business represents a significant portion of the estate. One solution to this may be a life insurance policy where the proceeds may provide the flexibility to balance inheritances, minimise the impact of capital gains tax and minimise the risk of successful applications under family provision legislation in the event of death. When do you need to consider estate equalisation strategies? Estate equalisation is applicable to any structure or size of business operation and where you identify a need for your client to balance the interests between family members or beneficiaries of an estate in the event of the client's death. Where a will is drafted the testator must consider who will be the beneficiaries and the extent to which the beneficiaries will benefit. For example, it may be the case that parents will want an equal distribution between their children. In many circumstances, it is relatively easy to plan the equal distribution of an estate where the estate holds a substantial amount of liquid assets. However, it is often the case that it is difficult to facilitate the equal distribution to beneficiaries because:
Generally, capital gains tax does not apply to the disposal of capital assets by a person as a result of death. Where the assets are transferred from the deceased to the beneficiary or from the deceased to the legal personal representative and then to the beneficiary, no CGT should apply to the transfer of the assets. However, if after receiving the assets, the beneficiary or the legal personal representative disposes of the assets, CGT may apply. CGT-Cost base of asset 1. Type of CGT Asset Assets acquired by the testator on or after 20 Sept. 1985 (post-CGT assets) Cost Base (or reduced cost base) Acquired The cost base (or reduced cost base) of the asset on the day the testator died. 2. Type of CGT Asset Assets acquired by the testator before 20 Sept 1985 (pre-CGT assets) Cost Base (or reduced cost base) Acquired The market value of the assets on the day the testator died. 3. Type of CGT Asset Trading Stock (eg Stock on hand in a business just before the testator died) Cost Base (or reduced cost base) Acquired The market value on the day the testator died; or the value determined by the legal personal representative on death where certain conditions are satisfied. It is noted that any pre-CGT assets held by the deceased at the time of death will be deemed to be post-CGT assets and generally subject to CGT on gains made after the date of death. As summarised in the table below, the beneficiary of the legal personal representative will be deemed to acquire the pre-CGT assets at their market value on the day the deceased dies. Therefore, if the asset is held for some time and then sold, there may be a capital gain if the market value increases, but nevertheless CGT has still been deferred. Where there are family members interested in the business, then the business interests should be disposed to them. Insurance proceeds may be used to provide for or compensate other family members not interested in the acquisition of business interests. What does an adviser need to do? They will need to gather information relating to a client's personal (such as the needs of their family members or other dependants) and business needs. It will be necessary to collect details of the client's family members and the potential beneficiaries of the estate upon death. It may also be necessary to involve the client's accountant and/or solicitor to achieve the best financial solution. Estate equalisation solutions Cash: The equitable distribution of an estate is relatively simple where cash is involved or there is a surplus of cash or liquid assets. In other words, cash provides the balancing asset and allows one beneficiary to receive the assets or interests in a family business relatively intact. Life Insurance: Cash is critical at the time of death and life insurance allows for the creation of additional liquid assets upon death. Policy proceeds provide flexibility to balance the inheritance and minimise the risk of successful applications under family provisions legislation. Case Study: Jane Dwyer, a single parent, has three children. Her only real asset is a small dental practice. The youngest son, James, has acted as her assistant for the practice. He is finalising his degree in dentistry. He intends to practice in his mother's practice as soon as he is able to. The other two children, Stephanie and Rachel, are both married and pursuing different career paths. Considerations that Jane would need to make are:
Each of the daughter's entitlements is represented as follows: 1. Market Value of their share of the assets in the practice $200,000 2. Cost Base of their share of the assets in the practice $50,000 3. Nominal Capital Gain $150,000 4. Discounted Capital Gain * (50% on Nominal Capital Gain) $75,000 5. Tax Payable on Discounted Capital Gain (48.5% if both daughters are at the highest tax rate) $36,375 * Assuming that both daughters choose the 50% discount method and no other concessions are available. If the assets in the practice were acquired before 20th September 1985, assuming that all other facts remain unaltered, each daughter's position would be as follows:
Solutions: Therefore, life insurance under this scenario could be used to cover the amount of tax exposure for each daughter. Alternatively, if James was to inherit the practice outright, life insurance could be used to provide the daughters with a benefit to compensate them in lieu of a share in the practice. Understanding the possible impact of family provision legislation The family provision legislation provides the legislative basis that empowers a court to entertain applications from spouses and dependants to vary the testator's testamentary dispositions. Only estate assets are subject to the family provision legislation. The general principle of the legislation is to ensure that recourse is available to applicants to provide for them financially in order to secure their proper maintenance, education and advancement of life, if this has not been properly achieved from the relevant estate. A court is only entitled, under the family provision legislation, to take the following steps: Step 1: Determine whether the deceased made adequate provision for the proper maintenance and support of the applicant. Step 2: If the deceased did not make adequate provision, then the court has the power to determine what amounts are adequate provision for the proper maintenance and support of the applicant. Therefore, the legislation may provide for the equitable distribution of estates, but the success or failure of such an application depends upon the facts and circumstances of each case. Conclusion Estate equalisation is an often overlooked, and yet vitally important, component of effective business financial planning and protection. Effective estate equalisation can ensure that businesses stand the best chance of success in the hands of a new generation of owners without residual ownership complications, and that all beneficiaries of an estate are appropriately provided for. Acknowledgement - Financial Planner's Digest - ING *Note: The above article highlights how tax planning, life insurance cover and estate planning knowledge come together to deliver the most efficient results. Advantage One was set up to provide for these services and ensure co-ordination under the one roof. Contact Tony Martin or Geoff O'Neil to find out more. |
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