What is, and what is not, in your personal estate?
This may sound like an academic question not worthy of a lot of thought. However, if you are in estate planning mode, it is critical that you answer this question correctly.
We have written a lot about assets that you consider to be ‘yours’, but which are actually held outside of your personal estate. For example, assets you hold in a family trust and your super. The important thing here is that you cannot always deal with these assets through your Will. You often need to put in place extra planning to ensure that these assets end up where you intend.
However, there is another class of assets that you need to be equally concerned about. These are assets that are in fact in your personal estate (and will be dealt with through your Will), BUT which you may not want to deal with through your Will. Confused?
Take for example, ‘unpaid present entitlements’ (or ‘UPEs’) due to you from your family trust. It is quite common for your family trust to make taxable income distributions to you each year that are not actually paid to you in cash. This results in the trust ‘owing’ you the amount of the distribution. Over the years these unpaid distributions can build up and become very significant. From an estate planning perspective, these UPEs are an ‘asset’ that you hold in your personal name – they are an amount owed to you personally by your trust.
This can have a number of unintended consequences.
UPE risks while you are alive
The first risk is during your lifetime. Many people use trusts to protect assets held within the trust. However, the UPE is an asset that builds up in your own personal name. If you are sued personally this is an asset available to your creditors. So the end result is that the ‘asset’ may be held in the trust, but the benefit of the asset can be got at by your creditors calling up your UPE – and effectively sucking the value out of the trust!
Another risk during your lifetime is UPEs in the name of your children. Once again, it is common to make taxable distributions to your children (e.g. if they are at Uni and not earning much). There is nothing to stop a child over 18 demanding payment of the UPE – at any time… The same applies to testamentary trusts that make distributions to minor children. They can call up any unpaid amount on reaching 18.
UPE risks when you die
The next level of risk is when you die – and this is when UPEs can seriously upset your estate planning.
Lets say that you have agreed with your children that one child will take over your family trust (the ‘business child’), and your other children will get the ‘balance of your estate’ (the ‘non-business siblings’). This often happens with business and farming families, when parents want to give business and farming assets to the business child taking over the business, while the balance of their estate is to go to the non-business siblings.
But what happens if the trust with the business assets also has significant UPEs outstanding to the parents when the parents die? These UPEs end up in the hands of the non-business siblings – and represent a liability that the business child needs to pay out to keep the trust assets. It may also be the case that the business child has already ‘paid out’ their siblings to some extent prior to their parents death – so paying out the UPEs effectively becomes a double-payment to the non-business siblings.
Let’s illustrate this with an example:
Andrew and Hannah run a business in a family trust. The business is worth $1 million and they intend to ‘give’ this business to their son Edward when they die. The balance of their assets (worth $2 million) will go equally to their two other children, Alex and Nicholas. However, over the years the trust has made unpaid distributions to Andrew and Hannah totalling $700,000. This sits in the family trust accounts as UPEs.
Edwards ends up with the trust with a business worth $1m, but with an obligation back to Andrew and Hannah’s estates of $700,000. So he gets a net $300,000. Alex and Nicholas share $2m in other assets, but also share in the UPEs of $700,000, giving them $1,350,000 each ($1m plus half of $700,000).
Not what was intended!
This is a very obvious example, but in larger estates the UPEs can get lost – but still have a material impact on the overall result.
A similar issue can occur with farm management deposits, or ‘FMDs’. Often these deposits are considered part of the ‘working capital’ of a farm operation, and the business child who is to inherit the farm expects to also receive these amounts. However, if the FMDs are held in the name of the parents, then by default they will end up in the parent’s ‘residual estate’ and therefore in the hands of the non-business siblings. Once again, not what may be intended.
The take-away message is that you need to carefully consider what assets are in your personal estate, and what assets are outside your personal estate, and put in place appropriate strategies to ensure that all of your assets end up where you intend. You also need to be careful to identify all of your ‘assets’ – which can include loans to and entitlements to and from your various ‘entities’.