What if you aren't a SKI-er?

Not the kind that involves the snow (although it may still be relevant for some) – rather “Spending the Kids’ Inheritance”.

SKI-ing may become a necessity because market conditions have led to an unexpected fall in their retirement nest egg, or perhaps unexpected and unbudgeted expenses have arisen.  In some cases, it’s because there was no real planning around leaving an inheritance for the children, so there simply isn’t enough to spread around.

What if you don’t want to be a SKI-er?  What if you want to leave something behind for the children?  Here are some considerations which may help to ensure you may leave and transfer wealth to the next generation, and whether there is a better time for doing it.

Decide when you want to do it – earlier or later

The main question here is whether you want to transfer amounts to others now or for it to happen through your will when you pass away.  Whilst it may be the case that transferring wealth through your will is an almost automatic process without much thought, it’s always important to remember that you should review the bequests and beneficiaries nominated in your will regularly to ensure they continue to reflect your wishes.

A decision to do it all through your will and knowing your nominations remain aligned to your desires doesn’t mean you can forget about the present.  If you have a real desire to transfer certain amounts to certain beneficiaries, consider how carefully you are planning to ensure those amounts are available. 

If you want to transfer some of your wealth earlier, you may have the certainty of knowing that a particular amount is going to go to the person or people you want it to, but you should remember two important things:

• Once you have given control over that wealth to them, you can’t take it back.  You won’t be able to change your mind down the track and wish you could give it to someone else.
• That wealth is no longer yours, and therefore it can’t form part of your own retirement funding plans.  So make sure you keep enough for yourself.

Are there specific things you want to achieve?

Sometimes a decision to transfer wealth to the next generation may be motivated by a specific reason. For example, many grandparents (or parents) want to ensure money is set aside to educate a future generation.  With schooling becoming more costly, knowing that you have been able to lend a helping hand can be an important and worthy gift.

There are ways specific outcomes can be achieved with more certainty than others.  Continuing the example of education, money can be set aside by a donor into an investment bond (sometimes referred to as an education bond).  The donor can maintain control over the bond, and the underlying investment decision, and know the money has been set aside for a specific purpose.  The donor may also decide when and how much money will be released in the future.  This can have advantages over just handing an amount over to a child/grandchild for the purpose of education costs, but then actually losing control over whether the money is ultimately applied to that purpose or another.

Impact on Centrelink benefits 

For retirees (or those close to retirement), any gifts need to be considered in case it has an impact on Centrelink eligibility.  There are limits on how much can be gifted any year and any gifts in excess of the limits will still be deemed to be an asset of the donor for up to 5 years, and could reduce entitlements to Centrelink benefits such as the age pension.

For example, there is an annual gift limit of $10,000, and a $30,000 limit over any 5-year rolling period.  Amounts in excess of these limits are deemed an assets under the Assets Test, and will have a deemed amount of earnings taken into account for eligibility under the Income Test.  Neither of these rules will stop you giving an amount away, but you need to consider their potential impact on retirement funding.

If you are close to retirement, but not yet eligible for the age pension, you still need to consider these rules, as any gifts made in the 5 years prior to you applying for the age pension will be taken into account under the above two tests. So a gift made with all good intentions today, could reduce your eligibility for age pension in the next few years.

Taxation considerations - pay now, later, or not at all

A decision on when to transfer wealth can also have tax considerations.  Whilst a decision should never be based on tax alone, if there is a change in the ownership of assets, then a capital gains tax (CGT) event may occur, which may have a tax impact.

As an example, if you choose to transfer the ownership of assets whilst you are still alive, then whether you sell assets to be able to transfer cash, or whether you simply change ownership of the asset, a CGT event may occur.  If a capital gain arises, then you may have to pay any relevant taxes.

If you wish for wealth to be transferred though your will/estate, then the treatment may be different.  If your estate sells an asset in order to have cash to satisfy a bequest, then your estate needs to account for any CGT.  If, however, you simply have ownership of an asset pass through to a beneficiary (i.e. without a physical sale of the asset), then the beneficiary essentially inherits the asset with any unrealised gains (and your cost base characteristics) and they will be liable for any tax when the asset is ultimately sold – with the gain calculated based on what you originally paid for it.

Can trusts help?

Another option to consider for intergenerational wealth transfer is the use of other structures, such as a trust.  It’s not uncommon to see some wills establish a testamentary trust – which is basically a mechanism to set up and provide funding for certain beneficiaries of your estate into the future, without passing actual ownership of the assets to those beneficiaries immediately.

Whilst not transferring assets immediately, a testamentary trust can allow you to choose who controls the investment decisions of assets that form part of the trust, but still allows you to ensure income is distributed to the right people.  But like the will itself, any intent to establish a testamentary trust via your will should be reviewed regularly to ensure that your nominated beneficiaries and future trustees are the right people.  And it is vital to ensure you get appropriate advice for the structuring of the trust and its terms.

As an alternative, you could establish a trust with the same intended outcomes and can continue to control investment and distribution decisions as a trustee of the trust.  Again, you should seek appropriate tax and legal advice in establishing a trusts in these circumstances.

Overall, a decision on how and when to transfer wealth between generations can be a complex process.  There are a number of things to consider, and advice should always be sought to ensure that outcome aligns to the original intent.

Regarding assets, the key limits as at 1 July 2023 are as follows¹:

To receive a full pension, assets (excluding the value of the primary residence) must be less than: 

^1. Indexed every 1 July. Source: Australian Government Services Australia.

To receive at least a part pension, assets must be less than:

^1. Indexed every 20 March, 1 July and 20 September. Recipients of Rent Assistance will have higher thresholds. Source: Australian Government Services Australia.

To get a transitional rate pension, your assets must be less than:

It’s important to note that if you get Rent Assistance, your cut off point will be higher.  Use the Payment and Service Finder to find out your cut off point.

Asset reduction strategies

There are a number of strategies that may be used to reduce asset levels, which may result in qualifying for a part pension or increasing the current pension amount received.

However, before reducing your assets it is important to bear in mind whether your remaining savings can support any shortfall in your retirement income needs, as any increased pension amount may still be inadequate. Personal circumstances can also change and increase the reliance on your reduced savings. For example, future health issues may require a move into aged care, which can bring increased expenses.

With that in mind, here are six possible asset reduction strategies to help boost your pension:

1. Gift within limits, for more than 5 years before qualifying age

If there is a desire to provide financial assistance to family or friends, gifting can reduce your assessable assets. The allowable amounts a single person or a couple combined may gift is $10,000 in a financial year or $30,000 over a rolling five financial year period. Any excess amounts will continue to count under the asset test (and deemed under the income test) for five years from the date of the gift. This is called deprivation.

If you are more than five financial years away from reaching your age pension age or from receiving any other Centrelink payments, you can gift any amount without affecting its eventual assessment once you reach age pension age.

How gift­ing can im­pact your pen­sion

2. Homeowners can renovate

Your home is an exempt asset and any money spent to repair or improve it will form part of its value and will also be exempt from the assets test.

3. Repay debt secured against exempt assets

Debts secured against exempt assets do not reduce your total assessable assets. An example is a mortgage against the family home, regardless of what the borrowed funds have been used to purchase. However, using assessable assets to repay these debts can reduce the overall assessed asset amount. Crucially, you must make actual repayments towards the debt; depositing or retaining cash in an offset account will not achieve this outcome.

4. Funeral bonds within limits or prepaying funeral expenses

If you wish to set aside funds or pay for your funeral costs now, there are a couple of ways to do this which may reduce your assessable assets⁵.

A person can invest up to $15,000 (as at 1 July 2023) in a funeral bond and this amount is exempt from the assets test. Members of a couple can have their own individual bond up to the same limit each. By contrast, if a couple invests jointly into a funeral bond, this must not exceed $15,000 i.e it is not double the individual limit².

In comparison, there is no limit to the amount that can be spent on prepaid funeral expenses. For the expenses to qualify, there must be a contract setting out the services paid for, state that it is fully paid, and must not be refundable. Importantly, both methods of paying for funeral costs are designed purely for this purpose and preventing assets from being accessed for any other reason.

5. Contribute to younger spouse's super and hold in accumulation phase

If you have a younger spouse who has not yet reached their Age Pension age and is eligible to contribute to super, contributing an amount into their super account may reduce your assessable assets. The elder spouse can even withdraw from their own super, generally as a tax-free lump sum, to fund the contribution. 

Investments held in the accumulation phase of super are not included in a person’s assessable assets if the account holder is below Age Pension age. Before using this strategy, any additional costs incurred should first be considered. Holding multiple super accounts may duplicate fees. Shifting funds into an accumulation account may increase the tax on the earnings on these investments to as much as 15%. Alternatively, earnings on the funds are tax-free if invested in an account-based pension or potentially even personally. 

Additionally, contributing to a younger spouse who is under Age Pension age, and still working, will 'preserve' these funds. They should also ensure they do not exceed their contribution caps³.

6. Purchase a lifetime income stream

Lifetime income streams such as an annuity purchased after 1 July 2019 may be favourably assessed^, according to the Social Services and Other Legislation Amendment (Supporting Retirement Incomes) Bill 2018⁴. Where eligible, only 60% of the purchase price is assessed. This drops to 30% once the latter of age 84 (based on current life expectancy factors) or five years occurs. 

To receive concessional treatment, the lifetime annuity must satisfy a 'capital access schedule' which limits the amount that can be commuted voluntarily or on death⁴. This is illustrated below:

^4. Source: Parliament of Australia. 

Voluntary commutations must follow a 'straight-line' declining value, falling to nil at life expectancy. The death benefit can be up to 100% until the investor reaches half of their life expectancy, at which point it will follow the voluntary withdrawal value⁴. 

Conclusion

Reducing your assessable assets⁵ within the relevant assets test threshold can provide many benefits such as increasing your existing pension or allowing you to qualify for a part pension, if you are currently above the upper asset test threshold. 

While it is tempting to intentionally reduce your asset levels to gain these benefits, it is important to remember the Age Pension payment rate is determined by applying both an income and assets test. The test that results in a lower entitlement determines the amount receivable. If the income test is the harsher test, reducing your assessable assets may provide little or no benefit. 

If the assets test is harsher, you should not lose sight of the fact that any reduction in your assets means there are fewer assets for you to call upon if required.

Next: How to determine asset allocation

Next: 4 smart strategies for estate planning