Are investment bonds the new will?
This report is sponsored by Generation Life. It was independently researched and written.
As more families find themselves at loggerheads over disputed inheritances, investment bonds can offer a less contentious, more tailored solution for estate planning.
A recent question in the Ask Paul section of Money generated heated debate on the issue of inheritances. The view of many readers was that bequests should be split down the middle. But for plenty of families the picture is more nuanced, and an equal share isn't always the answer.
For Australia's 100,000 blended families and 182,000 stepfamilies, equal - and unequal - inheritances can become a minefield of mixed emotions.
That's not to say inheritance issues are the sole domain of blended families.
In traditional families, it's not uncommon for one adult child to feel they are entitled to a bigger share of an estate because they have spent years caring for ageing parents while a sibling got off scot-free.
Adding to the problem is the fact that people don't always simply sit seething on the sidelines - many take their grievances to court.
Research by investment bond provider Generation Life found that 86% of claims over an estate are brought by the immediate family - adult children as well as current or former partners. And these cases can have a high success rate.
An estimated 74% of contested estates end up being distributed in a way that differs from the original will.
Of course, all these figures assume that a will exists. In fact, as many as three in five Australians do not have a will, a situation that could lead to major legal issues when they die.
What's fanning the flames of family disputes
Previous generations may have squabbled over who would inherit Aunt Ethel's Wedgwood figurines. Today, the stakes are far higher.
The Baby Boomer generation, with its $4.9 trillion in wealth, is expected to pass on about $224 billion annually in bequests between now and 2050.
While there is no suggestion that modern Australians are money grabbers, the high proportion of wills being contested suggests that, for some, the money is worth fighting for.
Given the potential for wills to be a legal minefield, and the sheer scale of wealth to be distributed, it may be time to rethink estate planning.
A report by Generation Life shows that the vast majority of Australians - almost seven in 10 - want to leave a legacy for future generations. The problem is that only 14% have a plan set in place to ensure this happens.
Not only does the desire to leave an inheritance make it essential to plan ahead, it also means careful planning is needed so that your legacy doesn't spark a family feud that has the potential to last
for years.
Options beyond a will
While it seems that many Australians don't have a will, most of us do, however, have superannuation - and our $4.1 billion pool of super savings isn't only used to fund retirement.
A Fidelity survey reveals that three in five Australians plan to leave their super to loved ones when they pass away. Already, up to one-fifth of all super withdrawals are bequests.
But super was never designed for this purpose. Les McGuire, a financial adviser and managing director
of Future Proof Wealth, explains: "Many people have taxable components within their super funds, which means that upon death, the super benefits will be taxed at 17%, resulting in your children receiving less."
There is another option for estate planning - one that is less susceptible to being contested, and without the punitive tax take of super bequests.
The solution can lie with investment bonds.
How investment bonds work
Investment bonds (no relation to government bonds) work much like a managed fund, providing a menu of investment options to select from.
Unlike super, there are no restrictions on when money in an investment bond can be accessed. That said, if you hold onto an investment bond for 10 years, withdrawals are regarded as 'tax paid', meaning they are free of any personal tax.
While there are no caps on the initial sum invested, additional contributions are limited to 125% of the previous year's contributions. Exceed this limit, and you reset the 10-year clock for tax-paid withdrawals.
Dig deeper, and there are aspects of investment bonds that can make them an effective estate-planning tool.
Felipe Araujo, chief executive of Generation Life, explains: "Estate planning is about structuring your affairs so that the right assets go to the right people. Investment bonds bring certainty over the assets that Australians have worked hard to achieve."
Investment bonds are reshaping inheritances
Hamish Clark is a senior financial adviser and director of Choice Capital. He believes investment bonds can play a key role in protecting a person's wishes when it comes to the distribution of their estate. He points to the strength of the Life Insurance Act, which governs investment bonds, that "makes it highly unlikely any disgruntled relatives can mount a successful challenge - something that can be less certain with a will".
The upsides of investment bonds can go further.
Clark notes that today's high rates of separation and divorce make it likely that more Australians will be concerned that their adult children, who may be happily married today, may separate and divorce
or become estranged at some point in the future.
"This brings real concerns that the wealth a person has worked hard to build up could be split across non-family members," says Clark. "Or even go to other current/ex-family members who may have largely abandoned their ageing parents, yet still feel entitled to their wealth."
He adds: "For this reason, I believe that investment bonds, as a non-estate asset, have a significant role to play in estate plans, both today and in the future."
Investment bonds also give older Australians the option to skip a generation altogether. Araujo notes that 80% of inheritances passed down from parents currently go to people older than 50 years. By this time, beneficiaries have often accumulated significant wealth of their own. "In some cases, the inheritance may be small relative to the beneficiary's own wealth," adds Araujo.
He says this is seeing growing interest among grandparents using investment bonds to give their grandchildren a healthy financial start in life, for example, by bequeathing the funds to buy a first home.
"It can ensure a bequest makes a lasting difference," says Araujo.
McGuire believes people of all wealth levels can benefit from holding investment bonds, ensuring their assets are allocated to the desired recipients at the right time and in the right way, tax-free.
He notes also that investment bonds can be used to navigate what may be deeply challenging family circumstances.
"One elderly client of mine sadly has no contact with her grandchildren, but still wants to leave a legacy for them," says McGuire. "By setting up separate investment bonds for each grandchild, there will be complete discretion about the inheritance. In this way, investment bonds have allowed my client to ensure she is remembered by her estranged grandchildren, without fear of legal wrangling that could see her final wishes overruled."
What to weigh up
You don't need much upfront cash to get started with an investment bond. Minimum opening investments can be as low as $1000. If you start small, bear in mind the 125% rule that will limit subsequent contributions. If you wish to add more, the answer can be to open another investment bond.
Investment bonds are known for their tax-efficiency because no tax is payable by the investor provided the investment bond is held for at least 10 years. However, the investment is taxed internally at the company tax rate of 30%, or potentially less after the benefit of franking credits and other concessions.
This makes investment bonds particularly attractive for anyone with a marginal tax rate of more than 30%, though potentially less tax-effective for those on a lower marginal tax rate.
Like all managed investments, investment bonds come with fees. Read the fine print to understand the fees you'll be asked to pay.
Three key pluses of investment bonds for estate planning
Generation Life's Felipe Araujo points to three features that are unique to investment bonds.
1. Certainty - investment bonds sit outside a will
An investment bond nominated in favour of a particular beneficiary is a non-estate asset that cannot be challenged in the same way as a will. Araujo says this provides the upside that "investment bonds bypass probate, ensuring faster distribution of asset".
2. Confidentiality
As investment bonds don't need to go through probate, the proceeds of an investment bond can be paid confidentially.
As McGuire puts it: "No other family member knows who received a particular inheritance." This makes it possible to pass on wealth to a particular beneficiary without raising the ire of other relatives.
3. Control - a direct say in who gets what and when
Araujo explains that an investment bond gives control over "how and when intended recipients can access the money".
For instance, the proceeds of an investment bond can be drip-fed to a beneficiary over a specified period - perhaps years.
This level of control can be a real plus for anyone wanting to provide for the long-term financial needs of, say, children with special needs or adult children who lack experience managing large sums of money.
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