Peter Townsend, principal of Townsend Lawyers, said of all the strategies to protect children’s inheritance, this is among the most common.
“Although for ease of reference, we refer to ‘life estate’ that may not be completely accurate as often the interest ceases if the surviving spouse remarries,” Townsend said.
Life interest involves the first to die giving the surviving spouse only a life interest in the deceased’s share of the estate so that they do not own the assets outright, but only have the use and benefit of them during their life or perhaps until they remarry.
On their death they automatically revert to the children, bypassing the surviving spouse’s estate and as a result not being available to the second spouse.
Townsend said there are several ways that a life interest can be achieved, including a formal life estate set out in the will, a testamentary discretionary trust set up in the will, or a simple right of occupancy set out in the will.
“Whichever way they are structured, the first-to-die wants to make sure that the surviving spouse doesn’t challenge the will under the family provision law to do away with the life interest,” Townsend said.
He added that a separate strategy involves the surviving spouse giving only a life interest to their second partner with the full ownership of the assets going to the children of the first marriage on the death or remarriage of the second spouse.
“This second strategy is problematic as there has been case law making clear that in most cases such a limited interest would not meet the deceased’s obligation to their second spouse,” he said.
Townsend said the willmaker may have assets in their will such as interest in property, a house, shares, investments, and interest in superannuation.
“Super can’t be dealt with in the will because it stands outside assets held by the trustee,” he said.
He continued that a life interest allows the willmaker to put in place provisions allowing a spouse or partner to use an asset or income from an asset that provides them with a benefit until their death or remarriage.
“If you’re talking about a matrimonial home, for example, and a spouse only owns half of it, the willmaker can give them a life interest in that part of the house either in the will or by putting that part in the estate in a discretionary trust inside the will,” he said.
“The right of residency is important from a tax point of view as it ensures it continues to be CGT free as a residence.”
As superannuation is outside of the will, Townsend said that if the willmaker wants to benefit the spouse but not give them outright all of the death benefit, they can create a reversionary pension or death benefit pension.
“That allows the remaining spouse to get an income stream from the superannuation and the terms may be that the pension lasts until they die or they remarry and then automatically commutes to a lump sum or the estate,” he said.
“If they don’t want to create a pension they can give all death benefits to the estate. People who can receive directly from superannuation are limited to SIS dependents and the estate and the willmaker could say the death benefit is to be paid to the estate. It then becomes assets of the estate and the will dictates how it is dealt with.”
Split families always the toughest. However life interest still problematic. The will will likely say the recipient of the life interest must maintain the property and pay outgoings. At what point is the requirement not met? From peeling paint and a leaky roof to a massively over grown garden or a dilapidated kitchen. Kids argue as one set pays the costs while the other benefits once the second dies.
I prefer, if finances allow, to leave separate funds on trust for capital needs. Still contentious in certain circumstances but potentially less so.
Also what happens if the recipient needs aged care? The aged care facilities will only pay to the estate of the resident no matter who pays the money in.
The only option I can think of is a loan agreement from the estate to the recipient and then seek to have it repaid from the estate of the recipient to the estate of the original testator.
It’s all tricky business.
I see more lawyers talkign about the importance to use “right of residency” rather than “Life interest”. Anyone care to explain the differences? I understand from the above article that “right of residency” helps maintain the PPOR CGT exemption but does the Kife Interest not offer the same?