Written by Karlisle Morocco
An inheritance often arrives at one of the most difficult times in a person’s life. In this article, we address the questions we are most frequently asked and explain why it is wise to avoid major commitments until you know what you are actually receiving.
Before turning to the financial considerations, it is important to acknowledge that, for most people, an inheritance follows the loss of someone close: a parent, partner, grandparent or friend. Receiving money in these circumstances can bring mixed emotions. It may provide welcome financial security while also serving as a reminder of the person who is no longer here. Some people feel uncomfortable even thinking about it, while others feel a strong sense of responsibility to honour the wishes of the person who left it to them. These feelings are entirely natural, and there is no need to have everything resolved straight away.
Many of our clients come to us at this point in their lives. Some have already received their inheritance, while others have been told they are a beneficiary and are waiting for the estate to be finalised. In either case, it is common to be weighing up a range of options, such as reducing the mortgage, supporting children, purchasing an investment property, or establishing a trust on the recommendation of a friend or colleague.
Alongside the emotional side, an inheritance often brings family considerations and a considerable amount of well-intentioned, but not always accurate, advice. Below, we address the questions we hear most often, beginning with the most important.
The first principle: avoid major commitments until you know what you’re actually receiving
It is natural, and sensible, to begin planning as soon as you learn you are a beneficiary. However, until an estate is finalised, both the amount you will receive and when you will receive it can be uncertain. For this reason, we encourage clients to avoid major financial commitments until they have a clear picture.
Estates take time to finalise. Obtaining probate, selling property, lodging the deceased’s final tax returns and settling debts all take time, and more complex estates can take considerably longer.
The final amount may differ from expectations. Investment values fluctuate, property may sell above or below its estimated value, and legal fees, agent commissions, outstanding debts and tax are all paid before beneficiaries receive their entitlements.
Wills can be contested. Eligible family members and dependants may be able to make a claim on an estate within a set period after the date of death, and for this reason many executors delay distributions until that period has passed.
Commitments can be difficult to reverse. Entering into a property contract, making a major purchase or promising funds to family members based on an anticipated amount may leave you financially exposed if the inheritance is delayed or smaller than expected.
Thinking through your options in advance can be very helpful. The key is to avoid locking in major decisions until you know what you are actually receiving, so that your choices are based on actual figures rather than estimates.
Do I have to pay tax on an inheritance?
Australia does not impose an inheritance tax or death duties. Money received from a deceased estate is not treated as assessable income, so the inheritance itself generally does not need to be declared in your tax return.
However, tax may still be relevant in several ways:
Earnings generated by the inheritance after you receive it, such as interest, dividends or rent, are taxable in the same way as any other investment income.
Where an estate earns income before it is finalised and part of that income is distributed to you, you may need to declare your share.
Capital gains tax may apply when you sell an inherited asset such as property or shares.
Superannuation death benefits are subject to their own tax rules, which are particularly relevant for adult children.
Inheritated property and shares
Capital gains tax (CGT) is generally not triggered when an asset passes to you from an estate; it may apply when you later sell the asset. How it applies depends on a number of factors, including when and how the deceased acquired the asset. Accurate records are therefore important, particularly for assets such as shareholdings that have been held over many years.
Special rules can also apply to the family home. Depending on how the property was used and how long it is held after the date of death, the tax outcome on a future sale can differ significantly.
Tax rules can also change over time, so the timing of any decision to retain or sell an inherited asset may affect the outcome.
Inherited superannuation
Superannuation does not automatically form part of a deceased estate. The super fund pays the benefit in accordance with any valid nomination or, where none exists, at the trustee’s discretion. The tax treatment depends on the relationship between the deceased and the person receiving it. Benefits paid to a spouse or a financial dependant are often treated differently from those paid to adult children, who may pay tax on part of the benefit and are generally unable to keep it within the superannuation system.
Will an inheritance affect my Age Pension or Centrelink payments?
It may. An inheritance can be taken into account under Centrelink’s means testing, which may affect your entitlements. Changes in your circumstances generally need to be reported to Services Australia.
Some people consider gifting funds to family members. However, Centrelink has gifting rules, and amounts given away above certain limits may continue to be counted as your asset for a period of time. It is important to understand how these rules apply before transferring any funds.
What about the mortgage?
For many people, reducing or repaying the home loan is one of the first options that comes to mind. Repaying debt provides a certain saving equivalent to the interest rate, and owning a home outright can offer considerable peace of mind. Higher-interest debts, such as credit cards and personal loans, are also commonly part of the conversation.
Some people hold funds in a mortgage offset account while they decide on a longer-term plan, as it reduces the interest payable while keeping the funds accessible. You may also hear the term “debt recycling”, a strategy that involves repaying home loan debt and re-borrowing to invest so that the interest may become tax-deductible. It can be effective in certain circumstances, but it carries risk and is not suitable for everyone.
What about superannuation?
Superannuation can be a tax-effective environment for funds that will not be needed in the near term. The trade-off is access, as superannuation is generally preserved until certain conditions are met, such as reaching retirement.
There are limits on how much can be contributed, and eligibility depends on factors such as your age and existing superannuation balance. Different types of contributions also have different tax implications. The rules are detailed, so it is important to understand them before making a contribution.
Helping family members
Sharing part of an inheritance with family, whether by assisting with a home deposit or supporting the next generation, can be very rewarding. There are, however, several questions worth considering. Should the funds be provided as a gift or a loan, and how might that matter if a relationship were to break down? Could it affect any Centrelink entitlements? And, importantly, how would it affect your own financial security?
Do I need a trust?
This is an area where matters often become more complicated than they need to be. Once a significant sum is involved, terms such as family trusts, testamentary trusts, bucket companies and self-managed super funds tend to enter the conversation, and these structures are sometimes presented as the natural next step for anyone with wealth to manage.
Trusts, companies and SMSFs can be useful in the right circumstances. However, our starting point is always the same: what do you want this money to achieve? For most people, the answer involves things like repaying the home loan, retiring earlier, supporting family, or simply having a financial buffer that provides security. Objectives like these can often be achieved without the need for complex structures.
Introducing a complex structure to achieve a simple goal can result in years of additional fees, administration and compliance obligations for a benefit that may be modest, or that may change as the rules evolve. Unwinding a structure later can also involve tax and other costs. In every case, the structure should follow your goals, not the other way round.
Allow youself time
An inheritance frequently follows the loss of a loved one. Grief can affect judgement, and significant financial decisions made in the weeks following a death are among those people most often come to regret. Many of our clients find it valuable to allow several months before making any major changes, holding the funds somewhere secure and accessible while they consider their options.
This can also be a time when unsolicited opportunities arise, whether a business proposal from an acquaintance, a property recommendation or an investment promoted online. As a general principle, a sound opportunity will still be available in three months’ time. Pressure to make a quick decision should be treated with caution.
Other frequently asked questions
Will my inheritance be protected if my relationship breaks down?
Not automatically. In the event of a separation, an inheritance may be taken into account when the property pool is divided. Holding the funds in your own name and maintaining clear records of their source can assist, but does not guarantee the inheritance will be excluded. If this is a concern, legal advice from a family lawyer may be appropriate.
What if I’m inheriting from overseas?
Australia does not tax the inheritance itself, although other countries may have their own inheritance or estate taxes. Once you own overseas assets, any income they generate, and any gain on sale, may be taxable in Australia. Maintaining clear records of the source of funds is also important.
Should I review my own estate plan?
Yes. Receiving an inheritance is an appropriate time to review your own will, enduring power of attorney, superannuation beneficiary nominations and insurance arrangements. As your financial position changes, your estate plan should be updated to reflect it.
Key considerations
Avoiding major commitments until you know what you are actually receiving.
Where the funds will be held in the meantime.
Keeping records of what was received, when, and the cost base of any assets.
How the inheritance may affect your tax, superannuation and any Centrelink entitlements.
Any existing debts, including your home loan.
What you want the money to achieve, before considering any structure.
Giving yourself time before making significant decisions.
Final thoughts
An inheritance can be a significant and meaningful gift, and often the final one a loved one is able to give. Making the most of it rarely requires complex structures or quick decisions. It requires patience, a clear understanding of what you want the money to achieve, and a plan tailored to your circumstances.
If you have received an inheritance, or expect to receive one, we would welcome the opportunity to discuss your situation and help you understand your options.
The information in this article is general information and does not take into account any person’s individual situation. You should always do your own research, or seek professional advice to assist you in making an informed decision about what suits your needs.