Strategy 17/08 – The plan to win over the rich

The Strategist Group recently sat down and documented more than 100 different strategies that financial planners may implement when dealing with clients that have put in place a self managed super fund (SMSF).

Some of these strategies may be available in a public offer or employer super fund, however, for the most part they are specific to SMSFs. Over the next few issues of Money Management, we will consider many of these strategies - who they can be used by; the benefits of using them; how a financial planner may implement the strategies; and most importantly, how to make money from the strategies. We intend to show financial planners that SMSFs are not a mystery.

SMSFs are in fact simple to use; are strategically well positioned for the high net worth or high net income clients; and have the capacity to accelerate the growth of a financial planning business.

The first and by far the most important strategic area for using a SMSF for a client is for estate planning purposes. Surprisingly, even the most experienced SMSF practitioner generally has little understanding or knowledge of the significant benefits that a properly tailored estate plan in a SMSF can deliver to a high net worth client. As many financial planners are well aware, the key to winning over or to retaining many high net worth clients is strategic estate planning rather than retirement income prowess.

At the outset we need to understand that the key to estate planning in any super fund, including a SMSF is the sole purpose test found in section 62 of the Superannuation Industry Supervision Act (1993). The sole purpose test provides that the trustee must ensure that the fund is maintained solely for retirement benefits for fund members and, importantly, for benefits for the member's dependants if the member dies.

As such, superannuation must be viewed as both a strategic retirement income vehicle as well as a strategic choice for estate planning purposes.

Estate planning case study

Bill Glass is 40-year old, high income earning executive with a spouse, Marie, and two young children aged 9 and 10. Bill and Marie are members of the Glass Family Super Fund with Bill's retired parents, John and Jan (aged 68 and 67 respectively). His children are not members of the family SMSF. Bill's employer allows Bill to contribute to the family SMSF and to date, Bill has been salary sacrificing into super, as much as is possible having regard to his age-based limit.

Bill and Marie jointly own a property on the Northern Beaches of Sydney which is valued at $1.2 million, with an outstanding mortgage of $600,000. Bill also has $100,000 sitting in a portfolio made up of six blue chip stocks.

In relation to the SMSF, Bill currently has $160,000 in benefits and Marie has $40,000. Bill's parents have more than $600,000 in benefits between them and both have commenced an allocated pension in the fund. The trustee of the fund is Glass Pty Ltd, a trustee company with all four members as directors.

Bill wants to ensure that his family is financially well looked after should he die and he realises that his current assets are insufficient to meet his estate planning needs. If he dies, he wants Marie to receive a lump sum to pay off the mortgage on the house and to allow her to live comfortably for the rest of her life without having to work again. He also wants the children to be looked after independently just in case Marie remarries and the children don't like their stepfather. He has in mind $30,000 per annum for each child to age 28 plus a lump sum of $300,000 on their 28th birthday.

In order to achieve his estate planning aims, Bill's financial planner has suggested that he takes out a life insurance policy to cover his estate planning needs. As most financial planners are aware, the cost of premiums for someone of Bill's age (depending on his health) is generally inexpensive compared to the cover the policy can provide.

For the purpose of our current case study, we will investigate the estate planning possibilities of Bill seeking $2,000,000 of life insurance to properly cater for his family's needs in the event of his death.

The Testamentary Trust

In the next issue we will consider the use of a SMSF, however, let us first consider the traditional use of a testamentary trust as an estate planning strategy for Bill. In that regard, the life policy will be taken out in Bill's name with the proceeds to form part of his estate if he dies. Thereupon, a direct bequest to Marie and a testamentary trust for the children would be put in place.

The use of a testamentary trust is a tax-effective tool for Bill, as each child beneficiary of the trust is treated as an ordinary taxpayer for taxation purposes.

The penalty taxation provisions relating to income for minors does not apply in respect of benefits from a deceased estate. Accordingly, the first $6,000 of income distributed to each child will be tax-free under the new tax-free thresholds.

However, there are downsides in using a testamentary trust as an estate planning tool. All income and capital gains earned by the trust must be distributed each year (until the entity tax regime is introduced on 30 June 2001) and will be assessable in the beneficiaries hands. There is no tax deduction for the life insurance premiums and the entity tax regime may apply in respect of a testamentary trust from 1 July 2001. As such, income and capital gains derived by the trustee of the fund will be subject to tax at 30 per cent. More importantly, the capital gains tax discount rules will not apply in respect of assets disposed of by the trustee after 30 June 2001.

In our next column we will consider the strategic estate planning consequences of the trustee of the Glass SMSF acquiring the life insurance policy.

<I>Grant Abbott is a director of The Strategist Group.