Take the guesswork out of gifting

There are two changes to gifting rules that advisers need to make sure their clients are clear on. The first is the replacement of ‘pension year’ with ‘financial year’ as of July 1, 2002, and the second is a new $30,000 gifting cap over a rolling five-year period.

While previously retirees could gift up to $10,000 per pension year (commencing from the anniversary of the first pension/allowance payment) without invoking the deprivation of assets penalties, they can now gift up to $10,000 per financial year. (Deprivation occurs where a person disposes of an asset or income for less than their value.)

And while replacing pension year with financial year makes things easier from a financial planning perspective, the change is subtle enough for many pensioners and part-pensioners to overlook it.

Likewise, retirees do not need to wait for their old pension year to pass before making a gift this financial year as all pension years came to an end on June 30, 2002, to make way for the new rules.

This means that theoretically, someone whose pension year previously started on June 28 could have made a gift on June 29 and again on July 1 without a problem. The gift made on June 29 would fall under the old rules.

The new cap on gifting — $30,000 over a rolling five-year period — starts from the beginning of this financial year. For couples, the $30,000 cap is shared jointly.

Basically, this cap means that retirees or soon-to-be retirees can now gift up to a maximum of $30,000 within any given five-year period starting this financial year, although there is still a maximum gift of $10,000 per financial year.

The period that deprived assets continue to count towards a person’s pension test after disposal remains unchanged at five years.

Advisers should sit down with clients who are nearing retirement at least five years before they intend to opt out of the workforce to work out how they are likely to fare under the Department of Family and Community Services asset and income tests.

This gives the client enough time to rearrange their financial situation if they want to qualify for a pension or part-pension, given gifts made within five years of applying for the Age Pension will come under the gifting rules.

For example, if the client ‘gifted’ (ie. transferred legal ownership of) a holiday house to their children six years before retirement, this would have no material affect on their pension assessment. But if they do it within five years, they’ll fall foul of the deprivation of assets rules.

Of course, gifting assets at any time can be tricky because of the costs involved in transferring ownership of title (such as capital gains tax and stamp duty), and the pros and cons need to be weighed up very carefully.

Some strategies for reducing assessable assets more than five years out from pension age include:

n Transferring assets, such as a holiday house, into a trust, with the client and other family members as beneficiaries. Provided that the trust is controlled equally by all beneficiaries, this can reduce the amount on which the client is assessed.

Expert advice should be sought before opting for this strategy, as unless the trust is set up correctly there is still a risk the client may be assessed on the entire asset. For example, a discretionary family trust would generally not satisfy the requirement.

n Transferring the legal title of an asset to a trusted relative (for example, son or daughter), who would otherwise have inherited the gift through the client’s estate.

On the flip side, clients who receive an inheritance just before retirement or at pension age can also inadvertently find themselves at odds with the asset and income tests. This is an area where retirees need to tread cautiously.

For starters, there’s nothing to be gained — and a lot to be lost — from instructing the executor of the estate to transfer assets to a third party. The transfer will be treated by social security as a ‘gift’ and deprivation of assets/income penalties incurred.

However, the client can use their inheritance to make home improvements without affecting the assets or income tests.

The other viable option available to a retiree in this situation is to purchase an asset-test-exempt income stream (complying annuity or pension).

If the client is nearing retirement, they can transfer the funds into superannuation prior to age pension age and then convert this into an asset-test-exempt income stream when they exit the workforce.

Additionally, retirees need to be aware of another prickly situation they can find themselves in by acting as a guarantor for a loan where the person defaults on their obligations.

Apart from the financial loss suffered, the amount repaid by the guarantor will be treated as a deprived asset for social security purposes.

The only way to get around this deprivation ruling is for the retiree to take appropriate legal action against the party for whom they acted as guarantor, because trying to recover the money they paid to clear the debt will change how it is assessed.

This is not an easy option when the party in question also happens to be a much-loved relative who has fallen on hard times.

As always, great care must be taken when assessing a potential retiree’s needs and all aspects should be taken into account before deciding on a strategy.

Lalita Mann is technical analystfor Zurich Financial ServicesAustralia.