Martin: Welcome to the business owners’ podcast where we throw aside taboos and share strategies for growing, protecting and exiting your business. My name is Martin Checketts and I represent Mills Oakley’s Private Advisory team.
Well, welcome everybody to a new season of the podcast! In this season I’ve got a very special guest, my colleague Troy Palmer! Welcome, Troy
Troy: Thanks Martin
Martin: So, Troy’s a colleague of mine at Mills Oakley. He leads our wills and estates planning practice. Before joining Mills Oakley, Troy was also a senior executive at National Australia Bank and he ran their wills practice nationally, so we feel very, very lucky to have him with us here today.
Now, in this series we’re going to talk about wills and estate planning for business owners. In my experience many business owners have set things up well in relation to their business, they’ve documented matters appropriately, but often they leave the personal side of the planning and put it on the shelf and forget about it if you like. And often that brings disastrous consequences. So, in this first episode of the season, Troy, can you lead off and tell us why it’s so important for a business owner to have a will.
Troy: Thanks Martin, so it does sound rather simplistic in terms of advising business owners to have a will, but it is just so important for a business owner to have a will because we need to think about what are the consequences of not having a will. If one passes away without a will in place, in each jurisdiction in Australia there are intestacy laws which dictate where ones assets will go. Secondly, who becomes the manager if you like of those assets when the person passes away. So under intestacy laws, that person is called an administrator, who’s role is akin to an executor, but an executor is very certain as to who will be appointed because it’s noted in the will whereas an administrator, it’s up to the discretion of the Court as to who is appointed there.
So if I die without a will and the majority of my assets are in Victoria and I live in Victoria, there’s legislation which says that the first $100,000.00 of my estate will go to my spouse if I have a spouse and children, 1/3 will go to my spouse and 2/3 will actually go down to my children.
If my children are under the age of 18 it’s typically held in trust until they reach the age of 18 at which time they’ll take control, so, quite often deemed to be too young for a child to take control of a significant amount of asset potentially, and also generally there’s no real asset protection or tax effectiveness built into that structure.
Martin: Troy, sorry, just to jump in at that point, so, if you’re married with kids and you don’t have a will, 2/3 goes to your children.
Martin: So what if there’s a business in there? What happens to the business?
Troy: So that’s where it can become really problematic, because in effect what that means is that spouse is entitled to 1/3 and children are entitled to 2/3 and then you’ve got the issue that, who is going to be the administrator? Who is going to deal with that particular business? Who is going to arrange the transfer? So, the intestacy laws are, in most cases, just simply not adequate and also if there’s another business owner involved, so if there is equity held by somebody else, then the continuing business owner will have to deal with the administrator of the estate, who then may not know, they may not have met before, this particular person may have not been involved with the business or in businesses generally and have no business acumen so, the intestacy laws for the most part are totally inadequate, particularly for a business owner.
Martin: Yeah, and just to pick up on a point that you made earlier, you spoke about if children receive an inheritance under the intestacy laws, then they kind of get that in their own name at age 18, right?
Troy: That’s right, so, generally when clients do a will, the vesting age that we nominate with children, depending on the instructions of the will maker, generally sort of around 25 years of age, maybe followed by 30 would be the next most popular and then 21, so, in the last sort of 15 years of practice when someone has written a will, I reckon I could count on one hand the amount of times where someone’s nominated 18. Obviously it’s very young, and also with the lack of asset protection that the intestacy laws apply to children, it just means that if that child is in a relationship or enters into a relationship or indeed into business themselves and are at risk of getting sued or going bankrupt there’s just no asset protection around that inheritance.
Martin: And let’s tease that out Troy because that’s a really important point. When you say there’s no asset protection, what do you mean in relation to that?
Troy: So under the intestacy laws, when a child attains the age of 18 or if they’ve already attained the age of 18 and this applies to the spouse as well, the assets vest in their own names personally. So, if surviving spouses enter into another relationship or a child was in a relationship or enters into a relationship, or into business themselves or into a risky profession, because they’re holding the assets in their own name personally, there’s no asset protection there which you can usually build into a properly constructed estate plan if there is a will involved because you would include things like testamentary trusts or life insurance or right to occupation all of those asset protection structures there a properly executed estate plan provides.
Martin: Yeah. So if you get the assets under intestacy, yeah, straight into your own name and therefore the assets exposed to family law claim, creditor risk and other risks.
Troy: Exactly right.
Martin: But through something like a testamentary trust that you can write in the will, you can protect that asset. It might just help for some of our listeners, Troy, to explain exactly what a testamentary trust is, because I know some people listening will understand that and some people won’t.
Troy: Sure, so to provide an understanding to the percentage of wills that we draw here at Mills Oakley that incorporate testamentary trusts, I’d suggest that probably 95% of the clients that we see have a testamentary trust built into their will. It sounds a little complicated on the face of it, but it’s not really. A testamentary trust in simple terms is a trust that is established in a will, that doesn’t come into effect until the will maker passes away. And probably best explained by way of example, if I have a client that has a standard will, when that particular person passes away, the assets vesting the beneficiaries in their own name personally and as we’ve just discussed, that doesn’t provide a whole lot of asset protection. But nor does it provide much tax effectiveness. So if that particular beneficiary, nice round numbers, if they were to inherit say $1 million, that might include some life insurance, it might include some superannuation, real estate, etc, that $1 million, when it goes into their own name personally, if the beneficiary was to invest that $1 million or put it in a term deposit or go and see their financial advisor to have it invested on their behalf and it generates, say, $50,000 a year worth of income, because the inheritance and because the assets are in the beneficiary’s own name personally, any income or interest that’s generated on that $1 million, the beneficiary pays tax at their normal marginal rate. So it may well be that half of that $50,000 is lost in tax.
Under a testamentary trust structure, if the $1 million was to go into a testamentary trust, there is a level of asset protection that is now provided in terms of depending on how it’s structured with family court proceedings, with any attacks by creditors and bankruptcy, etc, there’s a level of asset protection. Also from a tax perspective, same set of circumstances, go and see the financial advisor or go and put the money on term deposit, but this time it’s in the name of the trustee of the testamentary trust, and same amount of income is generated, but this time, depending on the form of the trust, it provides the ability for the trustee to split the income out when it comes to distribute to themselves, distribute to their spouse, but the big one under testamentary trusts is when you distribute to minors, so those under the age of 18, their taxed as you and I. So they’re taxed as adults, which means that the tax free threshold that we get, those minor beneficiaries also receive, which is very different from a family trust, where it’s not usually appropriate to distribute to minors under that sort of structure.
Martin: Wow, and that could be worth thousands of dollars per year, right?
Troy: That’s right, so that example that I gave earlier where $50,000 a year worth of income was generated on the $1 million, instead of me paying tax at my normal marginal rate and potentially losing half of that in tax, if I distribute $18,200 to each of my two children that’s tax free, and if I distribute to my wife who is on a lower tax rate than me, instead of losing half of that in tax in that example I could almost bring it down to zero, so there’s $25,000 saved straight up.
Martin: Wow, that’s amazing.
And for me a scenario that springs to my mind as you talk about this is families in business, and we see this a lot in that mum or dad might pass on, and at the time they do, their children are often in business for themselves, or maybe they’re now stepping up and running the family business – and I can only imagine that absolutely the last thing they want at that time is to have a whole bunch of assets hitting their personal ownership because a second later they could be sued, right? They could be made bankrupt or whatever.
Troy: That’s right, I mean, we’re quite good, as per your introduction, business owners, in terms of setting up some pretty good asset protection strategies whilst alive and one of those is typically holding assets in the less risky spouse’s name, so, if I’m in business myself and our principal place of residence is held in my wife’s name for asset protection reasons and let’s say, other assets are held in her name, the last thing I want is if she was to pre-decease me, for those assets to come back into my own name personally because I’m going to be very exposed and one might say well, transfer the assets out at that point of time but, to a family a trust or some other structure, but what can quite often happen there is that I’ll be hit with some pretty significant stamp duty or start thinking about capital gains tax and all those types of things whereas if there was a properly constructed Will, my wife would have included things like life interest and rights of occupation in her Will which would mean that I don’t necessarily need to put those assets back into my own name personally if she was to pre-decease me.
Martin: Yeah – and that’s a great insight isn’t it Troy. It might not in fact be the Will for the business owner that’s so important, it may very well be for their spouse because if the business owner is structured properly, they’ll hold little or nothing in their own name anyway and we’ll talk about that in the next episode – but yeah, very common for the spouse, who is not exposed to business risk, to hold the family home. Now without a Will, that family home could go – is this right – a third to the survivor and two-thirds to the children?
Troy: To the children, yes.
Martin: So you might not, in fact, own your family home!
Troy: That’s right! And we had an unfortunate situation we’re dealing with at the moment where a business owner actually owned the principal place of residence in his own name, which is quite rare, but my understanding is that he actually owned it pre-marriage. Unfortunately this particular chap passed away last year and he didn’t have a Will and the property as I said was owned in his own name, and he had two children 13 and 11, and the spouse, and it means that the house is basically shared between the spouse and the children, so, no Will in place so the intestacy laws applied which is not a very good result for anyone.
Martin: Hey Troy, thank you so much for all of those insights, it’s certainly given me some clarity and I’m sure those who are listening some clarity as to why it’s so absolutely a very good idea for business owners and their spouses to have a valid and binding Will.
In the next episode we’re going to talk about the difference between estate assets and non-estate assets and how they’re dealt with. So thank you for listening everybody and thank you Troy!
Troy: Thanks Martin.