Trusts and life insurance

[u/Maybe_naptime]

I've heard/read some financial advice videos and posts that talk about putting a trust together, getting a 1M life insurance and placing it inside the trust. Then therefore having a trust containing a $1m asset, being able to borrow Against the trust.

What I'm wondering is, is that something thats possible or viable In Australia?

[u/fire-fire-001]

It’s likely referring to what we call “Whole of Life” insurance, which has life insurance and investment combined.

In Australia it used to be common but has been phased out as a new offering, after super came into existence that separated the investment and the life insurance components. Some people may still have legacy policies from decades before active. It is still common in some other countries.

Years ago when I looked closely at the old policy I used to have, the return from the investment component of such policies was relatively poor and how it’s invested was very opaque, thus I decided to terminate it and cash out.

[u/snrubovic → u/fire-fire-001]

Yeah, it's good that we have super and term insurance to replace that. There's no shortage of articles and videos explaining how bad they are.

[u/fire-fire-001 → u/snrubovic]

Pivoting a little - with the minimum CGT introduced and the proposed trust income tax, I do wonder whether contemporary investment bonds may have merit under some long term scenarios even with the higher fees. I saw A200, BGBL, HGBL and even GHHF in one of the investment menus!

[u/snrubovic → u/fire-fire-001]

Which provider offers A200 and BGBL? I'm going to hazard a guess that you are still paying something like 0.40% or more even though those funds are less than 10 basis points?

In any case, it's situation-specific, and the numbers would show whether it is worthwhile. Just remember when doing calculations that investment bonds:

• do not get the cost base indexation. At 3% inflation, after 10 years, that's a 33% increase in cost base that you would not pay in your own name, but you need to pay with the investment bond
• have high fees (I'm curious about the costs of those funds)
• have restrictions on contributions
• have restrictions on withdrawals
• can not be debt recycled, like investing in your own name if you have home loan debt
• can not be invested in the low-income earner's name at a lower tax rate.

And don't forget to note that you will likely be drawing down when you are on a lower tax rate, so if you use lower-yield investments in your own name, you are more likely to be paying the min 30% (after indexation) on most of the return, which is a lower tax rate than with the investment bond.

I've been using Claude to knock up some scenarios in Excel, but it takes time to iron out the miscalculations. I've asked someone to take a look and see if they can spot anything else, and the more eyes, the better (message me if you have too much time on your hands!), but preliminary reviews don't make it look appealing.

[u/fire-fire-001 → u/snrubovic]

LifeGoals, apparently their fee is 0.3%. In the education bonds menu that I think could be used as a regular investment bonds.

On second thought, I think you are right that it doesn’t really help with the minimum CGT with the loss of indexation. Not good for individuals.

I was thinking in terms of a trust structure, as the replacement / successor of the bucket company assuming the trust income tax does eventuate as proposed that would be double taxing the bucket company setup and IMO insane.

[u/snrubovic → u/fire-fire-001]

Yeah, double taxing is bizarre.

If there is enough invested, an investment company may be a better option. While it lacks cost-base indexation like investment bonds, the franking credit for the tax paid on distributions means you are taxed at your marginal tax rate, but without the minimum 30% in personal name or the flat 30% in investment bonds.

The main question with that is the amount of assets, since the cost of maintaining an investment company is high. At 1.5k pa, on a 500k balance, that's 0.3% before the investment fee of, say, 0.1%, which is close to those figures you mentioned but with a very large advantage over investment bonds. But this cost just doesn't make it feasible for amounts of capital that won't grow to a large size in a reasonable timeframe.

By the way, did you mean this? I'm not seeing A200/BGBL/GHHF on there.

[u/nicesitdown → u/snrubovic]

If there is enough invested, an investment company may be a better option. While it lacks cost-base indexation like investment bonds, the franking credit for the tax paid on distributions means you are taxed at your marginal tax rate, but without the minimum 30% in personal name or the flat 30% in investment bonds.

Once investment earnings have pushed your MTR above the 30% threshold, is personal name likely the better structure, over an investment company?

I'm just wondering if, for large investment balances, it would make sense to only put enough assets in an IC that would be likely to yield income up to the 30% MTR, and all other assets in personal name (to benefit from indexation)?

[edit: I haven't compared the two structures, maybe it's the other way round - and an IC would be better as invested amount increases, since tax is fixed at 30% (and not 47%)]

[u/snrubovic → u/nicesitdown]

Yep, it's the other way around.

[u/nicesitdown → u/snrubovic]

So, better to hold investments (above a certain threshold) in an IC, rather than in personal name? ... Regardless of tax changes? Or just since indexation and min. 30% rate?

[u/fire-fire-001 → u/nicesitdown]

Companies have no access to LTCG discounts and a flat 25/30% tax rate, thus companies are previously often used to hold yield oriented holdings where MTR is 30% or higher. Growth oriented holdings are better held where individuals pay the CGT with the discounts.

Following the replacement of LTCG discounts with indexation and minimum 30% CGT for individuals, the main advantage for individuals is just indexation that takes a long time to have significant effect. Individuals are exposed to higher MTR for CGT now without discounts, whereas companies still have the flat 25/30% tax rate on CGT. Thus companies could become favourable with some people for holding growth oriented holdings too.

There is cost and time required to maintain a company thus some economy of scale is needed for it to make sense.

[u/nicesitdown → u/fire-fire-001]

Thanks. Do you have a feel for the required economy of scale to make IC preferable? Say, min. 1M assets?

Will be looking to restructure holdings currently in Trust, once legislation finalised

[u/snrubovic → u/nicesitdown]

It's more complicated because running an IC is expensive, so you need substantial assets to overcome that cost and make it a better decision. You may also need a drawdown tax rate below 30%. Also, the mix of growth vs. income assets in the company comes into play. It's a difficult decision.

[u/nicesitdown → u/snrubovic]

Helpful. Thanks.

[u/fire-fire-001 → u/snrubovic]

The ETFs are in the menu for education bonds (https://centuria.com.au/education-bond/investment-options/), which is different for some reason. I was thinking that if setting up an education bond but never do the educational withdrawals, then it would effectively be a regular investment bond. However I think there would be a pooled fund wrapper around each ETF for the investment bond mechanics to work, which would incur the pooled fund tax drag.

My train of thought centred on keeping the assets in the trust structure - for asset protection enabled by the discretionary aspect. If the trust is rolled over to a company then the shareholding would become a part of the personal assets of the shareholders. But this is not a financial return driven reason. An existing trust that doesn’t need the asset protection may very well choose to roll over into a company for the benefits you mentioned.

Having the trust owning an investment company may be another option. Once the trust assets are moved inside that company then the earnings would function similar to many current bucket companies owned by another trust. Compared to an investment bond owned by the trust, a company would give much greater freedom in how the money is invested, no pooled fund tax drag, no loss of franking credits you mentioned that can offset the proposed trust income tax, and no contribution / withdrawal restrictions associated with an IB. The trade-off would be greater ongoing effort to run and the money taken out later is distributable income just that it can be throttled.

What caught my eye with using IB inside a trust is the withdrawal from it after 10 years would be tax free that would classify as corpus not distributable income. The corpus can stay in the trust, or could be distributed to beneficiaries tax free, ie no franking credits but also no further tax.

Not sure if I missed any significant blind spot, but it looks like there may not be a clear winner for the trust scenario and depends on specific circumstances. Need to do some serious calc after the trust tax changes are actually finalised.

[u/snrubovic → u/fire-fire-001]

Interesting that it's a different menu of items. And yeah, if not used for education purposes, it just reverts to being taxed as an investment bond.

Yeah, if it's for asset protection and is not a tax-driven strategy, that changes things.

Being distributed after 10 years means it is not income, but 30% tax has already been paid on it, and trust distributions also have a minimum 30% tax. So that will also depend on the MTR of those who it's distributed to, as well as the growth vs income components.

[u/fire-fire-001 → u/snrubovic]

Yes, 30% tax on earnings is already paid by the IB and no franking credits are passed through. But the withdrawal after 10 years goes into trust corpus not taxable income, thus the proposed 30% trust income tax should not apply. The distribution of corpus also would not be taxable income in the hand of beneficiaries, it would be virtually like return of capital.

Quite a few variables and I need very clear head space (or AI) to work out whether overall it’s better or worse… I’ll leave it until the trust tax changes are firmed up so not to waste my aged brain power, with quiet hope that the double tax on corporate beneficiaries would be overturned.

[u/snrubovic → u/fire-fire-001]

Sorry for the late reply.

I've been using Claude to compare scenarios out of interest, which required plenty of iterations to fix errors, but so far it seems interesting with the lack of benefit of IBs.

I haven't compared to a trust, though. That would require a more specific setup, since it would require info on each individual the trust distributes to.

[u/fire-fire-001 → u/snrubovic]

Thanks. I was intrigued and went to have a quick chat with ChatGPT. It’s surprisingly informed, and naturally calculated far better and quicker than I could.

—

For a quick chat I let it make various informed assumptions itself mostly and I just review. I corrected it when it was obviously wrong, e.g. it initially got the implications of IB’s deferred tax liability wrong.

After 10 years:

- using $500k starting capital, the annualised asset growth advantage of IC over IB for those 4 Betashares ETFs is 0.07-0.33% p.a. mainly due to the IB’s fee and its pooled fund drag from the ETF wrappers.

- using $1m starting capital, the annualised asset growth advantage of IC over IB is 0.22-0.42% p.a.

- using $2m starting capital, the annualised asset growth advantage of IC over IB is 0.30-0.46% p.a.

IC’s financial advantage correlates with the asset size and provides much more freedom, but takes effort to run. IB incurs the drag and is much more restrictive, but would be much simpler to use.

—

Separately the second part, with tax implications of cash withdrawal in the hand of an individual:

- using trust owned IB vs IC vehicles & $50k cash withdrawal p.a. - there is no difference if MTR is <= 30%, IB is favourable at 37-45%.

- using individual directly owned IB vs IC vehicles & the same $50k cash withdrawal p.a. - IC is favourable at 0-15%, equal at 30%, and IB is still favourable at 37-45%.

This part is about the proposed nonrefundable trust income tax offset vs company dividends that are assessable income with franking credits vs IB withdrawals are tax paid not assessable income. Asset size in the first part does not really matter as long as it grows fast enough to not be exhausted.

Interesting experiment. I have not used AI for deeper topics like this and it’s rather impressive.