Multiple Bucket Companies as an Estate Planning Strategy

A Bucket company is a company set up to receive profits from another entity – usually a discretionary trust. The bucket company usually does nothing else, except receive money and make loans or directly invest perhaps. Over time the value of the bucket company will rise as money is coming in but not going out. Therefore, it will become increasingly important to consider in regards to estate planning and asset protection.

One estate planning strategy is to set up one separate bucket company for each child so that when the controller of the companies dies each company’s control can be passed on rather than having multiple people inherit the control of one company.

Example

Homer has 3 kids. He wants to leave them approximately the same amount of his assets 1/3.

Homer has decided to set up a discretionary trust to use to invest in shares. He seeks legal advice on the difficulties with leaving the control of the trust to more than one person so has that covered. But after a while the dividends of the share investments are building up so Homer sets up 3 bucket companies with 3 separate discretionary trusts with one trust holding the shares in each bucket company.

When the dividends come in, he causes the trustee of the share trust to distribute 1/3 to each company. Over a period of time the companies end up with large amounts of retained earnings which and then lent back to the share trust.

Homer dies.

Each of the bucket companies is then passed to each child – actually nothing is passed but the control of the bucket companies is arranged so that Child A controls Trust A and Bucket Company A.

This way things will be easy to divide. There is no more than one child involved in one company so if they want to cause the company to make loans, invest, pay dividends or close down they can do so without the need to effect or even consult with their siblings.

For a Discussion go to:

https://www.propertychat.com.au/community/threads/legal-tip-195-multiple-bucket-companies-as-an-estate-planning-strategy.38768/

Strategy: Take a Wage Haircut and Move to a cheaper area

If you moved to a cheaper area to live and took a haircut on your wage, it might not be as bad as you think. This is can speed up financial independence and reduce stress and give you a better quality life.

Example of a $20,000 wage reduction

After tax income on $100,000 would be $73,883 (2018-19 tax year)

After tax income on $80,000 would be $61,383

So, a $20,000 reduction in gross income means only a $12,500 reduction in real terms

Try working it out yourself at https://www.taxcalc.com.au/

But the real benefit may be the savings with home ownership.

An equivalent house costing say $1mil in Sydney v $600,000 in Adelaide (for example)

Repayments on $1mil at 4% pa are          

  • $4,774 per month for 30 years with Total interest payable $718,695

Repayments on $600k at 4% pa are         

  • $2,864 per month for 30 years with Total interest payable $431,217

The repayments on the smaller loan mean a cash flow saving of $22,920 per year – which more than makes up for the lower wage income.

Furthermore, if you consider commuting times – you might be saving 1 or 2 hours per day living outside of Sydney.

Living costs may also be generally cheaper. Consumer prices are supposedly about 12.75% higher in Sydney than Adelaide:

https://www.numbeo.com/cost-of-living/compare_cities.jsp?country1=Australia&country2=Australia&city1=Adelaide&city2=Sydney
https://www.numbeo.com/cost-of-living/compare_cities.jsp?country1=Australia&country2=Australia&city1=Adelaide&city2=Sydney

Consider also the quality of life.

Conclusion

It can be worth moving out of Sydney and living elsewhere and this can be the case even if you were to take a substantial haircut on your income.

The 2 broad methods of Debt Recycling

Broadly speaking there 2 ways to ‘debt recycle’.

Debt recycling is the conversion of ‘bad debt’ into ‘good debt’. See http://www.structuring.com.au/terry/recycling-debt/what-is-debt-recycling/

  1. Use the income from investments to pay down non-deductible debt, then borrow to invest further, or
  2. Selling investment assets and using the funds released to pay down the non-deductible debt and reborrowing

The best approach might be a combination of the 2 methods.

Example

Bart has owned a few investment properties for a few years. They are positive geared by $100 per week so that is about $5,200 per year in extra funds he can use to pay off his non-deductible home loan.

But the properties have about $500,000 in equity in them.

Bart only owes $400,000 on the main residence so what he could do is to sell the properties, pay the tax and used what is left to pay off the main residence debt, and to reborrow to buy more properties.

This way he uses a combination of the 2 debt recycling methods.

Of course, there is a lot else for Bart to consider such as, most importantly, his ability to qualify for finance to buy more properties.

Tax Strategy: Use Capital Losses Quickly – Recycle debt + death

Some people have carried forward capital losses. These losses can usually be carried forward until the taxpayer has a capital gain which can ‘soak up’ the capital loss.

I think it is a good idea to use up these losses as soon as possible.

The main reason being that losses are ‘lost’ at death. If the taxpayer dies their loss cannot be passed on to any other person who could utilise it. Don’t lose a loss!

Example

Bart bought a property in a mining town for $1,200,000. He ended up selling it for $700,000 and has a carried forward capital loss of $500,000.

Bart dies and leaves a rental property that he owns to his sister Lisa. The property has a $500,000 capital gain.

Unfortunately, Bart’s loss will not benefit anyone. Lisa will inherit the investment property pregnant with a $500,000 gain, yet she cannot benefit from the loss.

Had Bart sold the investment property before his death he might have made $500,000 tax free and this money could have been passed onto Lisa. He might have even sold the property to Lisa – perhaps with vendor finance if she couldn’t have afforded a loan. Also, if Bart had a flexible will his estate could have sold the property and possibly used up the gain.

Another reason to use up capital losses is their benefits with debt recycling. Making capital gains without needing to pay tax will mean there is more money with which the non-deductible debt can be reduced.


Example of Debt Recycling

Lisa has a $100,000 capital loss from some bad share investments many years ago. Because of this she has a large amount of debt still outstanding on her main residence. But this has not stopped her investing in shares again. She has learnt from her mistakes and is now making some good capital gains.

If Lisa’s shares increased in value by, say $20,000 in the first year, she could sell these shares, pay no tax, and use the proceeds to pay down the non-deductible debt, and then invest in more shares and repeat.

Doing this has 2 advantages

  1. It uses up the loss, and
  2. It produces tax free capital gains which can then be used to pay off the non-deductible debt quicker.

Speak to your tax lawyer or tax agent.

How to Fund a New Discretionary Trust

Discretionary trusts are generally started with just $10 or $20. Mostly trusts are established for a trustee to hold shares or property for the benefit of a beneficiary, so how does the trustee get the deposit or money to do this?

There are basically just 3 options to consider:

  1. Gift

A gift is an irreversible transfer from one person to another.

It is better than a loan for asset protection against bankruptcy because if the gift giver goes bankrupt generally the gift will not be available to creditors (but the claw back laws need to be considered).

Gifts to discretionary trusts may not be ideal though because when you die the gift will not form part of your assets and cannot be passed via your will.

If the gift giver is borrowing money to gift to a trust the interest will not be deductible.

Gifts should be documented with a deed.

2. Loans with interest

A loan can be made with interest accruing. However, interest is income to the receiver. Interest may be deductible to the trust if it is using the borrowed money invest, s 8-1 ITAA97.

The interest rate could at market, under market rates or higher than market rates. Each has different consequences.

But a person cannot contract with themselves, so you could not lend to yourself if you are the trustee.

Generally, someone borrowing money to lend to the trustee should consider charging interest to the trust. This interest would need to be at least the same interest that the bank is charging you. But the question you should be asking is if the bank has a first mortgage security over real property and charges say 4% to you, if you lend to the trust at 4% without security would this be a market interest rate? Are there any Part IVA consequences?

A loan should be documented with a written loan agreement which would be either a contract or a deed.

3. Interest free loans

Many like to make interest free loans to trusts because there are no direct tax consequences and the loaned money would generally come back to the lender at death and therefore form part of their estate and can then pass into a testamentary discretionary trust.

But a major issue with loans is the various state limitations acts. This could cause a loan to become unenforceable if there has been no activity with a loan for 6 years (NSW law). So, a loan made say 7 years ago which is interest free and no transactions have happened will not be recoverable if the borrower refuses to pay back. You might think that you are not going to sue a related trust, but you must remember that if you set up a trust you are just in control temporarily. If you lose capacity, go bankrupt or die the control of the trust will pass to someone else.

Interest fee loans should be documented in the same way as loans with interest.

Which method should you use?

You should all get specific legal advice from a lawyer, but as a guide:

  1. If you have cash and are concerned about bankruptcy a gift might be worth considering
  2. If you are not concerned about bankruptcy and have cash, then an interest free loan may be worth considering
  3. If you are borrowing and on-lending the money to the trust a loan with interest may be worth considering.

If you do make a loan you must adhere to the terms of the loan for it to be effective.

Being Both Executor of a Deceased Estate and Applying for Super Death Benefits

The executor of an estate has fiduciary duties to maximise the estate of the decreased. There can be conflicts of interest where someone is both executor and they apply, in their personal capacity, for the superannuation death benefits of the deceased, and this is because they are trying to avoid having the super death benefits paid into the estate, to benefit themselves.

Example

Mum and Dad divorce many years ago, son dies without a will. Son has about $40k in assets plus about $400,000 in super death benefits. Under the intestacy laws where a person dies without a spouse and children then both parents will benefit equally from the estate.

The issue here is that $40k is in the estate and will go to each parent in the share of $20k each.

If the superfund pays the death benefits to the estate the parents will get another $200,000 each.

If the superfund pays the mum, dad will miss out on $200k and similar if the superfund pays dad.

But, by mum applying for the benefit herself she is depriving the estate the money which means she is potentially breaching her duties as executor. As executor she should be asking the superfund to pay the money into the estate – it is her legal duty to do so.

 Moral of the story – seek legal advice before accepting the position of executor, especially if the deceased

An Example of How poor Ownership Structuring Can be Painful.

Homer and Marge own 5 investment properties all jointly as Joint Tenants. All in NSW and with a combined land value of $1,200,000.

Homer is on the top marginal tax rate and Marge doesn’t work.

They have reached their borrowing capacity.

They have just paid off their main residence and are saving about $10,000 per month.

Issues

  1. Land tax

Combined land tax is $9,236 (2018 year)

If they have owned $600,000 worth of land each then there would be no land tax

  • CGT

If they sell any investment property 50% of the gain will go to Homer. They can’t divert the income to Marge.

  • Paying Down Debt

They have excess cash, ideally this would applied to Marge’s debt as she would pay less tax. But as all the loans are joint they are stuck with reducing the debt relating to both Homer and Marge

  • Offset Accounts

Similar with the cash savings/buffer. It must go into an offset account liked to a joint loan so Homer’s income will increase.

Death Planning

Because they own everything as joint tenants if one dies there is no opportunity to get half of the assets into a testamentary discretionary trust. This will result in extra tax being payable after the death of one of them.

Possible Solutions?

As they have reached their borrowing cap there may not be much they can do if they cannot qualify for a loan. But they could consider

  1. Spouse A selling 50% of the property to Spouse B.
  2. Selling on property and buying a replacement in Marge’s name only
  3. Save up and lend cash to a trustee of a discretionary trust which will buy property and then divert the rental income to Marge
  4. Sever the Joint Tenancy so they hold the existing properties as Tenants in Common in equal shares – no duty, no CGT and easy to do without triggering a loan reassessment. They could then each leave their shares of the properties to the trustee of a testamentary discretionary trust controlled by the other spouse. Half the rents could then be streamed to the children potentially tax free.
  5. Etc

Loan Tip: Overcoming Cash out Restrictions When Buying Main Residence

This strategy is simple yet often overlooked.

Strategy: When buying a new main residence borrow 80% to acquire it, whether you need to or not.

Example

Bart has $400,000 cash and wants to buy a new main residence for $500,000. He plans to borrow $100,000 and then later set up a LOC to invest.

He borrows $100,000 and settles on the purchase. Then he asks for a $100,000 LOC and the bank starts asking questions. Eventually, after giving a DNA sample Bart is approved, but they want a statement of advice from a financial planner saying that Bart will invest in shares.

Lisa is in the exact same situation. Lisa gets some credit and tax advice and borrows $400,000 to buy her main residence. At application stage she splits the loan appropriately so that at settlement she can pay down 2 loan splits and is left with one split with $100,000 outstanding.

  • Lisa had no questions asked about future investment plans,
  • Lisa got the lower main residence rates for all of her splits (prob paying 1% less than Bart),
  • Lisa isn’t incurring any extra interest or costs, and won’t until she draws on the splits, and
  • Lisa has split the loans for tax purposes already.
  • Lisa has saved by not needing to pay a financial planner tosatisfy the lender.

In summary, Lisa has overcome the cash out restrictions and gotten a lower interest rate.

Tax Tip: The effect of Taking a Year off Work to Save CGT

If someone sells a property and has a large capital gain is it worthwhile taking a whole year off work to save tax? In my view it is always great to take a year off work, but it might not actually save you that much tax.

Example

Richie Rich is about to sell an investment property with a $200,000 capital gain. He is sick of it under performing and draining him with land taxand has a low yield. Richie is toying with the idea of taking a whole year off work to save CGT. Is it worth it?

Let’s assume Richie earns $100,000 in his job, and the sale will happen in the 2018-2019 financial year.

If he sells the $200,000 gain will be reduced to $100,000(due to holding it longer than 12 months) and added to his other income for the tax year. The result is an annual income of $200,000

Tax on $100,000                   $26,117          Net income   $73,883

Tax on $200,000                   $67,097          Net income   $132,903

Difference                              $40,980          Difference      $59,020

The Capital Gain will mean $40,980 in extra tax payable for the year.

This means by giving up a year’s income from work Richie would only earn $100,000 from the capital gain. Therefore, he will save $40,980 in tax by not working.

But not working means he has less income, working the full year in which the sale occurs will net him only $59,020 as opposed to his normal $73,883 (a difference of $14,863).

He would need to determine if the effort of working is worth the pay cut of $14,863 which is about $286 per week.

He should also factor in transport costs to work and other work-related costs – clothing, lunches etc.  and there are also heaps of non-financial things to consider. There would be time to do other things such as:

  • Start a business
  • Travel
  • Study
  • relax

Written by Terry Waugh of www.structuringlawyers.com.au

Offset in the name of the lower income earner

Once you have paid off your main residence you will probably want an offset account on one of your investment properties. This will be a useful place to store cash from rents and wages and also to save up a buffer for emergencies.

Where you have used the strategy of buying properties in sole names, some in the name of Spouse A and some in Spouse B, you can move money around to create tax savings.

You would generally want the cash in the name of the lower income earner as this spouse would generally be the one paying the least tax. Where there are several lenders involved (with that spouse) you would choose the lender with the highest rate as this will produce the highest return.

Money in an offset means less interest is incurred which means more income from the property.

Example

Homer is on the top marginal tax rate and his wife Marg has a taxable income of $0. They each own 2 rental properties. They have just paid off their home and old man Simpson has died and left them with $200,000 cash.

Where should they put it?

The answer, from a tax perspective, would be in an offset account attached to Marg’s loans.

Loan A is at 5% pa and Loan B at 5.5% pa. Both have offset accounts.

In this situation if $200,000 is deposited in:

Loan A the savings would be $10,000 per year. Marg would pay no tax on this

Loan B, the savings would be $11,000 per year. Marg would pay no tax on this.

There would no extra tax to pay as Marg’s income is $0 before this, and after depositing her income would be either $10,000 or $11,000 both of which are under the tax free threshold.

Let’s say Homer had 2 loans with each at 6% pa. If the $200,000 was deposited into either of Homer’s offset accounts the interest savings would be

$12,000 per year.

But as Homer’s interest decreases by $12,000 his income increases by this amount and because he is on the 47% tax rate 47% or $5,640 would be lost in extra tax.

Thus after considering tax the funds would be better placed into the offset account on Loan B belonging to Marg.

Keep in mind the legal consequences of ownership in different names too:

  • asset protection
  • estate planning on death
  • effect on spousal loan strategies

Perhaps a private loan agreement, even at nil%, can assist in legal planning.

This is also another reason to consider purchasing in sole names.

 

Written by Terry Waugh, CTA & lawyer at Structuring Lawyers, www.structuringlawyers.com.au