Many baby boomers are planning for retirement and the complexities caused by second (and sometimes subsequent) marriages continue to cause concern for not only themselves but also their spouses and their children.

The issues are varied and include the consideration of family discretionary trusts, asset protection, testamentary trusts and minimising challenges to their wills by marauding relatives.

Lawyers use many tools to assist them in meeting the concerns of the clients. In this article, we will briefly discuss life interests and how they can be used within the context of planning for retirement and putting together an estate plan that really works.

Life interests

A life interest can be of great assistance in dealing with the competing interests of beneficiaries.

An equitable life interest is an interest in property granted by the will maker to the “life tenant” who is typically granted the right to possess a property (very frequently real property) for the duration of their life and to receive the income from the property (for example, if it is rented out to a third party) until they pass away.

On the death of the life tenant, the will of the will maker provides for the property to pass to another person, called the “remainderman” or the “remainder beneficiary”. The property does not form part of the life tenant’s estate when the life tenant dies.

Some people grant life interests during their own life but it is more common to do so via their will.

One common way to use a life interest is for a testator (the will maker) to give a life interest in the family home to their current spouse and then state that on the death of the spouse, the property is to pass to the children of the will maker’s first marriage.

The details of the life interest need to be carefully set out in the will, otherwise, disputes can arise. Who is to pay for the rates and levies? What about maintenance costs? What is the power (if any) of the life tenant to sell the property and buy another one from the proceeds? Can the second property be more expensive than the first? If the second is less expensive, then who gets the net proceeds of sale? What if the life tenant needs to go into a retirement village down the track? Who manages the financial aspects of these transactions if the life tenant suffers from Alzheimer’s disease or has otherwise become incapacitated?

Similar interests

Sometimes a will maker wants to give their surviving spouse (or child) a “right to occupy” nominated premises for life. This would be suitable if the will maker seeks to only give possession to the nominated beneficiary but not give any right to income. The period of occupation can be stipulated as being for the life of the beneficiary or for so long as the beneficiary chooses to reside there, or for a specified period – for example, until the beneficiary marries.

A third option is to give a beneficiary a mere licence to occupy the property. This means that the beneficiary can occupy the property but has no right to exclusive possession and typically, the right to occupy the property is at the discretion of the legal personal representative of the deceased.

Stamp duty and CGT

If a life interest expires in accordance with the provisions of the will, then typically stamp duty will not apply to the transfer of the “remainder interest” in the property to the remainder beneficiary because it is a conveyance pursuant to the will. The same applies as regards CGT.

What about an early surrender of the life interest?

The beneficiary may want to dispose of their life interest or bring it to an end or otherwise surrender it. This could occur for a number of reasons. A remainder beneficiary may want to do the same.

Reasons for wanting to do so include a desire to avoid ongoing accounting, legal and other costs in relation to the life interest. It could be that the life tenant or remainder beneficiary wants to pass the property on to the next generation.

The disposal of the right is treated for capital gains tax purposes as the disposal of an asset – just like any other. Regardless as to whether any money is paid for the disposal, for the purpose of the person disposing of the interest, it will be taken to be disposed of at market value and there will be a capital gain (or loss) on its disposal.

The CGT provisions of the Income Tax Assessment Act 1997 will accordingly apply. Stamp duty may also apply.

Will makers should not be concerned about whether, after their death, the life tenant or the remainder beneficiary may decide at some stage in the future that they wish to dispose of or surrender their interest under the will. Presumably, they will have good reason for wanting to do so, and the right of the life tenant or remainder beneficiary to do so reflects the flexibility of the use of life interests. None of us can accurately predict the future.

Can a life interest be disclaimed?

One way to avoid the possible application of CGT and stamp duty on the disposal or surrender of a life interest is for the beneficiary to disclaim the interest upfront.

If the disclaimer takes place before the beneficiary receives the life interest, then there is no CGT to be considered.

However, some cases say that a beneficiary is taken to have accepted the life interest if, after being made aware of it, they do not take steps to disclaim it within a reasonable period of time. So timing is important.

How do you value a life tenancy?

Whilst valuation will become necessary to calculate the cost base on its creation and on the deemed proceeds on a surrender, it can be difficult to value a life interest and a remainder interest.

The valuation depends in large part on the terms and conditions of the arrangement and also on the age of the life tenant. Access to the online tables published by the Australian Government Actuary are available from some state revenue offices and these can be of great help to your accountant when working out the valuation.

Leigh Adams, Special Counsel at Owen Lodge Lawyers, specialises in the entry and exit of business partners, estate planning and litigation.