Avoiding the house of cards:
Protecting assets, income and business interests against an unexpected death - Stacy Barnes

 


How would your financial circumstances and responsibilities change if your business partner suddenly died?

 

A client of Pro-Active Accounting Firm Pty Ltd was looking to review their Estate and insurance plan in 2016 and were referred to NextGen Advisory to manage this area. The client’s circumstances, are as follows:

(Client names and specific details withheld for privacy, note, this is based upon a real case study).

Case Study Circumstances:
Joe, aged 51 is married to Janet age 44, Janet has a chronic illness requiring ongoing care.  She receives a government pension for her condition. Janet’s condition is deteriorating based on the nature of her condition.

  • Joe & Janet have adult children from previous marriages, they’re not ‘financial dependants’. However, Janet’s 19 year old daughter (Joe’s step daughter) still lives with them.

  • Joe works full time and cares for Janet as needed. Joe has a 50% shareholding in a company with his best friend Steve, this business is worth $3 million should it be sold on the open market. Steve runs the business on a daily basis.

  • Joe & Steve, also have a Self Managed Super Fund (SMSF) together that has a borrowing for an investment in a residential unit. Joe has other real property assets, a Family Trust and other debts.

  • Joe has an old Will, drawn up 10 to 15 years ago which doesn’t include new assets acquired since or cater for the company assets.

  • Joe has only $300,000 of life insurance held in his Family Trust.

 

Joe’s Concerns:

  • Care for Janet if Joe passes away in the form of an ongoing income stream, enough included to cover the 19 year old’s expenses as needed.

  • Joe is concerned about Janet’s illness impacting on her capacity to manage financial requirements and felt a lump sum payout would not be suitable. A strategy that delivers regular payments is required due to her inability to return to work and her need for simplicity.

  • Based on current arrangements, control of shares in the company would automatically go to each partners’ spouse in the event of death. Joe & Steve don’t want to work with each other’s spouses, mainly because they don’t know anything about running this business. As the spouses may not be in a position to effectively manage a decision about the sale of their inherited share of the business to the surviving shareholder, the business could be significantly impacted while an outcome is negotiated. Even worse, the spouse could sell to an unrelated party, creating further obstacles for the business and the surviving partner.

  • Each partner doesn’t have funds readily available to buy the other half of the business should one partner pass away. A solution to this needs to be devised to prevent an outsider, or a group of outsiders having an opportunity to buy in, without the consent or control of the surviving partner.

  • To address these risks, Joe & Steve agreed the surviving shareholder should gain the first right or refusal to the deceased’s 50% shares.


Advice:

In giving this advice, a variety of different scenarios had to be considered, thinking laterally and adopting a strategy that included some of the following:

  • Legal entities were required to form a compliant structure that allowed for an effective strategy to be implemented.

  • The legal entities had to be included in plan along with an outline of how the Estate deals with each one differently and individually from a control & perpetuity perspective (SMSF, Family Trust, Company, joint and personal holdings)

  • Expected Capital gains of company sale, value of their company and expected growth

  • Possible claim on Estate and from whom

  • Financial situation of both business partners, debts and assets, asset types and liquidity.

  • Income Requirements of Janet

  • Taxation on life payments in the hands of the Estate and dependants

  • Backup plans if Life insurance couldn’t be obtained

  • Review current SMSF estate legislation (Changed 1 July 2017)

  • Domino effect of each element of advice and how it would affect the Estate as a whole


Basis of Advice:

To meet Joe’s wishes, needs and concerns we produced a Statement of Advice highlighting his exposures and risks with comprehensive remedies to the potential issues provided. This included detailed advice on the professionals & legal instruments that would be appropriate to close the existing gaps.  Joe accepted the advice presented and agreed to implement the strategies.

One of the key elements of the advice was to establish two separate life insurance policies (among other insurances such as Income protection & Trauma). The first was to be held in the SMSF and the second in his personal name attached to a shareholder agreement and Funding agreement to deal with the company shares upon death. Further, his Will was updated and the assets of each entity were highlighted along with how they would be treated/controlled on death.

Life Benefit 1 –SMSF

The assets of Superannuation do not automatically fall into your Estate as governed by your Will, therefore if the Super doesn’t fall into the Estate’s pool of wealth, then it can not be contested, it’s a form of asset protection for your Estate wishes.

  • $1.5 million of cover was written for Joe, held and paid for in the name of his SMSF on his behalf.

  • The formula for this level of cover was calculated to provide a set amount to go to the Estate to fill the gaps required for loans and a benefit for each of his two children and an ongoing pension for his wife which will stay in the Fund, calculated to suffice her ongoing needs for the remainder of her life.

  • A binding Death nomination (BDN) was drawn up allocating how Joe wanted this benefit to be paid upon his death. This is binding and overwrites the Will’s wishes giving further protection against challenges.
     

Life Benefit 2 – Company

On death, shares in any company fall back into the Estate and get dealt with by who you appoint to manage your directorships in your Will, usually your spouse.

  • In this scenario, we advised the clients to implement a Buy/Sell agreement which we recommended Oncore Legal draw up.

  • The agreement stipulated the value of the business shares ($3 million) and the members agreed the only trigger event for activation of the buy/sell would be that of death, when triggered the surviving director would get first right or refusal of the shares, before the Estate.

  • It was identified that neither director would have the funds available to buy out 50% of the value of the shares in the near future. So we advised a Funding Agreement accompany the buy/sell, the funding in the form of Life Insurance.

  • We wrote each directors’ insurances to the value of $1.5 million which indexed up annually in line with CPI. The cover was held in the individuals’ personal names so cover would be paid into the Estate. The clients agreed to ignore insurance for Capital Gains Tax on the sale of the business.
     

Actual Outcome:

Joe unfortunately passed away in June 2017, leaving behind Janet, his adult children & his business partner. He was aged 52, the death was sudden and very unexpected.

Process & Outcome:
The NextGen Advisory team applied for the claim on the Life insurance’s totalling $3 mill+. This process consists of the Insurance Company going through all the deceased’s answers on their original insurance application and matching it to the deceased’s Medicare records.

If no non-disclosures exists, then the claim should pay. The Insurance company also needed Grant of Probate in certain occasions. This life claim took 5 months to complete, to NextGen Advisory & the client’s credit, is was 100% successful. 

Insurance Payout SMSF:

 This client’s insurance policy owned by the SMSF on Joe’s behalf paid $1.6 million into the SMSF, not the Estate.

  • As there was a valid BDBN on file, the surviving trustee Steve, had no discretion but to follow the direction of Joe’s nomination. (Without this valid BDBN, Steve could have paid the money where ever he wanted…)

  • The portion Joe nominated to go to his wife Janet was allocated to her as a ‘Pension’ from the SMSF. This should fund the remainder of her living expenses paired with her Govt. Pension for the remainder of her natural life.

  • Janet’s holding will remain in the SMSF environment, asset protected. All earnings on her pension investments in the SMSF will be tax free, so long as she pays her minimum pension annually. This will also stop the force sale of the investment property held in the SMSF as funds can remain in the SMSF to continue to pay down the borrowing. She will also need to become a member of the SMSF with Steve, unless she decides she wants her own personal fund.

  • The remainder of funds from the SMSF death benefit were paid to the Estate to be divulged by the Will.

 

Insurance payout – Company Shares

Joe was insured for the value of the shares in the company, and successfully received a payment of 1.5Million plus some additional amounts as the policy indexed annually, this was paid to the Estate.

  • As soon as this amount was banked into the Estate, the Buy/Sell & funding agreement ordered the transfer of shares to the surviving business partner Steve.

  • The Estate received the value of the shares and in return Steve now has 100% control of the company.

  • The Estate now has $1.6 million available to pay down loans and disburse to his dependants based on the wishes of his Will, the estate received the market value of the business with no effort.

*****

Steve is very pleased with this outcome & Janet is now meeting with me to gain Financial, Investment & independent SMSF specific advice based on her new situation. Accounting Firm Pty Ltd will manage the Estate returns and company CGT advice. Legal Company Pty Ltd is managing the Estate till completion.

To see this type of scenario to fruition is rare, while the situation is sad for all concerned, the one positive outcome is knowing that those left behind now have the financial security that allows them to grieve and move on with dignity and avoiding further distress caused by the uncertainty that would have otherwise been experienced.

If the correct advice is provided initially and the strategy is accepted and implemented without delay, a claim and resolution for a significant event should produce an outcome that supports the surviving parties.  

As a result of a referral from a proactive Accounting Firm who identified the need for a solid and effective risk mitigation strategy, the thorough advice and work provided by both NextGen Advisory and Legal Company Pty Ltd, Joe’s wishes have been honoured and those who were most important to him have been supported.

What can we learn from this?:

  • Don’t lie on your Insurance application, can you imagine if this didn’t pay!

  • Seek professional advice and understand the credentials and experience of those you appoint to give it to you.

  • Understand that estate planning in not cheap, but can be priceless.

  • You are not immortal, all humans who have lived have died so far, you don’t know when and neither do I.

  • Understand that you leave behind dependants, it is your responsibility to manage your estate prior to passing away, life insurance is good but with no estate plan, its incomplete.

  • Don’t mess around with poor quality or ‘over the phone’ Insurance providers, again you get what you pay for. NextGen only use the top companies in Australia to insure our clients, because we have a conscience.

  • You don’t always need insurance, its only there to fill a gap, your financial plan should be working to close.

  • Have a good team around you, pull together your resources and take your time! 

Please note this is in no way advice or the guidelines for such.

 

To follow this case study, a few key terms:

Life Insurance: Paid on the event of premature Death/terminal illness. Either accidental, natural or self-inflicted. Level of cover is calculated specific to each individual clients needs, to pay down debt and maintain surviving beneficiaries living expenses in the deceased’s indefinite absence.

Buy/Sell Agreement: A buy/sell agreement is a contract entered between business partners to allow for the buy out the other partner's interest in the business should a specific event occur. Events which may trigger a buy/sell agreement include death, trauma, long-term disability, retirement or bankruptcy. (We will focus on the event of ‘Death’ only in this study)

Funding Agreement: An agreement attached to the Buy/Sell on how (should an event be triggered, like Death) would the funds be paid to buy out the other partners interest. In this instance the funding has been structured to come from a separate life insurance policy.

Binding Death Nominations: A nomination as to who receives your Superannuation benefit, in what proportions and how (lump sum/Pension) on your death. This nomination, if binding and valid, leaves no discretion to the surviving trustee of the Super fund as to how your benefit is paid.

 

The ability to add a death nomination to the policy held in the Family Trust is also available.