This is the most common inheritance move, and the one with the biggest opportunity cost.
Many people that receive an inheritance use the money to upgrade their home, pay down their home mortgage, or take an epic holiday.
And while these things aren’t ‘bad’, they don’t do anything to build your investments or wealth — meaning they don’t move you any closer to financial security.
For example, if you use a $300,000 inheritance to pay down your home mortgage, you do reduce your interest bill — but you miss out on the opportunity to build an investment portfolio that could be delivering you $30,000 in growth and income every year for the rest of your life.
This is potentially the difference between buying yourself some comfort today, and setting up an income for life.
To avoid this trap, when you receive an inheritance you should be asking yourself how you can use the money to build your investments, not just reduce debt or increase lifestyle.
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Not understanding super death tax
While we don’t have inheritance tax in Australia, there are tax implications when you inherit different types of investments.
One of the most overlooked traps in Australia’s inheritance system is the tax that hits inherited super money — and this mostly affects adult children.
If your parent passes on money from their super, and you’re not classified as a dependent under the tax rules (i.e. over 18 and financially independent), you could be taxed at up to 32 per cent on the balance of the super fund.
For example, if you inherit $500,000 in superannuation money, you could be paying tax of up to $160,000, taking a big chunk out of the money your parents have left behind.
The good news is that this tax is largely optional, but only with the right planning.
A ‘withdrawal and recontribution’ done while your parents are alive allows them to convert their super money into ‘tax free’, meaning there’s no tax when the money is inherited — and it also gives some tax benefits to mum or dad while they’re living off their super money.
The rules around this are a little complicated and confusing, and it requires some smart planning.
But with the amount of tax savings up for grabs, it’s worth having the conversation with your folks to make sure they’re fully across the issues and opportunities here.
Not having a properly structured will
Over 60 per cent of Australians don’t have a valid will in place according to statistics from Finder, and it’s likely that even more people haven’t updated their will in years.
This is a terrifying statistic, because without a valid will in place, any money distributed is based on the law, not necessarily the wishes of the person leaving the money behind. This can lead to delays, disputes, and unnecessary legal costs.
Even with a will in place, most people don’t realise they can protect assets and drive tax efficiencies by using a testamentary trust. This type of trust allows inherited income and assets to be distributed in a way that’s more flexible, and more tax effective.
For example, any income paid through a testamentary trust to children under the age of 18 sees them taxed at adult rates, creating tax savings into the tens of thousands of dollars each year. This structure can also help to protect assets from divorce proceedings or relationship breakdowns, keeping inherited assets in your family.
If you’re leaving money to kids, or expecting an inheritance from your parents, getting the right will and structures in place will make a big difference to how long that money lasts and what it can do for the people receiving it.
Not having a structured will in place before your death can cause mayhem for your family and loved ones. (Source: Getty)·MoleQL via Getty Images
Not having the conversation with your parents early
There aren’t a lot of people that enjoy talking about death and money, but avoiding this conversation can be seriously costly.
When these issues are left unsaid and unexplored, it can lead to confusion, bad choices, and missed planning opportunities.
Whether you’re expecting to leave an inheritance or be on the receiving end of one, it’s important you know what assets exist, where they’re held, how they’ll be taxed, and what the will says.
Understanding who the beneficiaries are, and whether trusts are in place will help you make better decisions and put a smarter plan in place.
Having these conversations while everyone is healthy and capable can avoid a lot of stress and uncertainty in the future, and will give your family the best chance to make the most of the money being passed on.
The wrap
Inheriting money is one of the biggest and most important financial moments for your family, but it rarely gets the attention or planning it deserves — and instead is handled poorly with a lack of communication and a lack of strategy.
The key is to treat a potential inheritance as an opportunity to grow your investments, not just upgrade your lifestyle. You should be clear on how super is taxed, put the right will in place, and don’t leave this all to chance.
Most importantly, talk early. You’ll get the best results when you plan ahead, not just react under pressure.
Ben Nash is a finance expert commentator, podcaster, financial adviser and founder of Pivot Wealth. Ben’s new book, Virgin Millionaire; the step-by-step guide to your first million and beyond is out now on Amazon | Audiobook.
If you want some help with your money and investing, you can book a call with Pivot Wealth here.
Disclaimer: The information contained in this article is general in nature and does not take into account your personal objectives, financial situation or needs. Therefore, you should consider whether the information is appropriate to your circumstances before acting on it, and where appropriate, seek professional advice from a finance professional.
