Navigating an Incoming Inheritance: 4 Essential Considerations to Remember

More than $3.5 trillion in inherited funds are expected to change hands within Australia during the next 20 years, with Australians enjoying one of the highest inheritance payout rates anywhere in the world.

According to investment bank HSBC’s Future of Retirement report, Australians pass on average US$502,000 (AU$662,532) to their heirs, almost four times the global average of US$148,000, with 69% of Australian retirees interviewed planning to leave an inheritance. People don’t often leave their entire estate to one person, so what legacy does the average beneficiary receive? Approximately AU$79,000, according to research from the Australian Housing and Urban Research Institute (AHURI).

This payout rate is significantly higher than has been the case for previous generations, with higher property prices and ever-increasing retirement savings creating larger and larger estates to be handed from one generation to the next.

Does Australia have a death tax?

Unlike most OECD countries, strictly speaking, Australia hasn’t had an inheritance or estate tax (sometimes known as a ‘death tax’) for the past few decades, so this has also encouraged Australians to hold on to their estates until they pass, rather than distributing assets to the next generation while they’re alive.

The exception to this is where funds are inherited through superannuation.

If, for example, a person inherits funds from a loved one’s superannuation account and they are not a dependant, the transfer can trigger a superannuation death benefit tax. The definition of dependant is slightly different for who you can pay a death benefit to (superannuation law) and how the death benefit will be taxed (taxation law). The ATO also explains that a super death benefit can be made up of tax-free and taxable components, depending on how the contributions were initially made into superannuation.

The ATO advises that when someone dies, who their super balance gets paid out to, how the money was initially contributed into the super fund, and whether the benefit will be paid as a lump sum or an income stream can all impact how this benefit is treated for tax purposes.

Can you avoid the death benefit tax?

The death benefit tax can be reduced if the person leaving the funds withdraws the money and places those savings outside superannuation as part of their general estate before they pass. But given most people don’t know exactly when they will die, this is a rare event. In any case, doing so may also have other unintended consequences, as funds within super are not treated as part of your general estate.

The only other way of avoiding this death benefit tax is to establish a family trust. However, establishing a family trust can be a complex and expensive option and requires sophisticated legal and tax advice before being implemented.

Receiving an inheritance

Receiving an inheritance can also be complex, and professional advice should be obtained regarding how to best manage and invest any funds received. For example, regarding any Centrelink entitlements, inherited funds are included for the purpose of the asset test. Therefore, they are subject to the normal deeming regulations and will impact pension entitlements accordingly.

For most people, the biggest challenge is to find a way to transfer these inherited funds into their own superannuation, where they can be invested within a tax benign environment. The rules governing just when and how much can be contributed to super will vary depending on your age, whether you are still working or not, and how much you already have in super.

This is where you need to seek good professional advice.

Managing your legacy

As estates become larger, it is increasingly important to get good advice to ensure your assets are distributed in line with your wishes. The simpler and more straightforward your Will, the more likely it is to be successfully implemented.

In addition, many advisers encourage clients to put in place a living Will, where, either in writing or via a conversation with your beneficiaries, you outline precisely what your wishes are and the reasons behind them.

By doing this, you are likely to discourage any challenges to your Will - challenges that can be extremely costly. Moreover, given that challenges can be financed by funds held within the estate, the prospect of challenges can in themselves sharply decrease the remaining assets to be distributed.

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The information contained in this article is general information only. It is not intended to be a recommendation, offer, advice or invitation to purchase, sell or otherwise deal in securities or other investments. Before making any decision in respect to a financial product, you should seek advice from an appropriately qualified professional. We believe that the information contained in this document is accurate. However, we are not specifically licensed to provide tax or legal advice and any information that may relate to you should be confirmed with your tax or legal adviser.