The intergenerational wealth transfer will see many assets bequeathed. Most of these assets won’t be cash. Share portfolios are a common way that beneficiaries will receive assets – especially when the owner is an income investor that is living off dividends without drawing down on the capital of the portfolio.

This means that investors can inherit large portfolios – geared towards income – where they must immediately consider the consequences of additional income tax and the cashflow management issues that they bring along with it.

Here are some of the considerations for inheriting a share portfolio.

Tax

There is no inheritance tax in Australia, which means that there’s no immediate tax consequences of inheriting shares. However, there will be future tax consequences for the beneficiary.

Similar to investment properties, equities are split into two categories – those that were acquired prior to September 1985, and those that were acquired after. This milestone date signals the establishment of Capital Gains Tax (CGT), and therefore will have different tax treatments.

Equities that were acquired prior to September 1985 will treat the cost basis as the date of the owner’s death. Equities that were acquired after will keep the cost basis at original date of purchase. Depending on the size of the estate, this can be a significant capital gains tax burden upon sale.

If you are selling the asset, CGT is added to the income of the beneficiary. It may be worth considering the best way to dispose of the asset in relation to this. There are a couple of options:

• If the recipient is young and they have not reached their full earning potential, their taxable income may be lower. This could be a consideration as a lower marginal tax rate will apply.

• Disposing of the asset in parcels in separate financial years so lower marginal tax rates are utilised.

As mentioned, income tax is also applied on all dividends received. Say a younger person on a low salary inherits a $1,000,000 portfolio. The dividends are being reinvested. Without the income coming into their bank account, the tax bill is going to sting. Cashflow can be an issue and require the sale of assets to fund the tax debt, or to source the funds from elsewhere. In this case, it is important to plan properly – the sale of assets to fund a tax bill will trigger another CGT bill at the end of that financial year. Plan accordingly or see a financial professional for advice.

Misalignment of assets to goals

It is likely that if you have inherited shares, they have been purchased with the previous owner’s financial goals in mind. This can often differ from the beneficiary. For example, I had a friend that received a large parcel of BHP shares as an inheritance. This friend was an investor who had actively avoided mining shares as part of their investment strategy due to ESG considerations.  She wanted to focus on making investments in companies that she believed were making a positive impact. Although thankful for the investment, she divested and invested across assets she already owned.

It is not always an ESG or ethical misalignment. It could be stock characteristics – inheriting growth or income stocks or inheriting a large portion of international shares are other examples that may set your asset allocation off kilter. It is more likely than not that the shares aren’t going to be a perfect fit.

With consideration of the aforementioned taxes, divesting can happen in a few ways:

• Turn off dividend reinvestment. One strategy is to turn off dividend reinvestment and to redirect the income to other assets until an opportune time to realise the capital gain. This is a slower burn but works if you are able to afford the income tax obligations and don’t mind holding onto the original assets. Over time, they will make up a smaller part of your portfolio.

• Sell in parcels each financial year to temper capital gains and reinvest in aligned assets.

• Sell and use the funds outside of the share market – such as towards a mortgage, or to travel.

Early inheritance

Nobody likes talking about death, but ideally, parents and children should discuss both the estate plan and the specific assets held. Transparency is beneficial. Most of the investors that I speak have an innate desire to better their children’s lives and are purposeful about planning bequests.

If a parent chooses to leave money to their children, they want the money to be useful. It is worth a conversation about the intentions for the funds because the tax situation can be managed prior to death. I understand that this is uncomfortable, but it can end up benefiting both parties.

This article has mentioned a few times that younger people are likely to have lower marginal tax rates. There’s another group of people that are likely to have lower marginal tax rates – those in retirement. Tax situations are unique, but in many cases a retiree will have a lower marginal tax rate than their children. If the funds are held in super, I’ve written an article that specifies the various tax treatments depending on your circumstances.

Proper planning can determine whether it is worth selling the assets while the owner is alive, pay the taxes and hold the funds in a way that will benefit the child the most. If the beneficiary wants to use shares to fund a mortgage, to travel, or any other goal that requires liquidating assets to cash, it may be a pathway worth considering. After all, it may bring parents joy to see their beneficiary’s lives enriched while they are alive.

If you are unsure about what to do with your inherited shares, we can assist in developing a plan, incorporating a tax-effective pre- and post-retirement strategy tailored to your situation and retirement goals. Please call Humble Goode on (08) 7477 8252.

Original source: https://www.morningstar.com.au/insights/personal-finance/251304/what-to-do-when-you-inherit-shares

General Advice Warning:

The information on this website is intended to be general in nature and is not personal financial product advice. It does not take into account your objectives, financial situation or needs. Before acting on any information, you should consider the appropriateness of the information provided and the nature of the relevant financial product having regard to your objectives, financial situation and needs. In particular, you should seek independent financial advice and read the relevant product disclosure statement (PDS) or other offer document prior to making an investment decision in relation to a financial product.