All you need to know how to ensure tax-efficient inheritance

Most people equate estate planning with writing and registering a will, but that is just one part. For larger estates, you must create family trust structures, assign Power of Attorney (POA) to the right member, and engage in succession planning.

Estate planning 101 — know the basics

Like in any financial planning, even estate planning begins with making an assessment and evaluation of the assets and liabilities and arriving at net worth. The second step is to identify the beneficiaries. Money earned by the family head during their lifetime has a different set of rules, as compared to inherited property. Hence, needs like education and maintenance have to be prioritised. Thirdly, an estate preamble must lay down the goals and objectives, which include needs, lifestyle, and charity. Having set the rules of the game, it is now time to get to the action plan.

This includes creating the family trust, appointing nominees, assigning POA to execute, agreeing on distribution of assets etc. It is always better to have these discussions with family members in the presence of the lawyer to get buy-in. The final step is to give a legal shape to the estate plan. This includes drafting the will, getting it vetted, registering the will for legal sanctity, giving necessary authorisations for POA, minor care etc. Obviously, this process must be done at the earliest, so that one can also review and update the will at regular intervals.

Also read | There is a way: How fraudulent wills can be detected

Using HUF for estate planning in India

While Hindu Undivided Family (HUF) is a traditional concept, its nature  has evolved over time in India. How does HUF fit into estate planning? It has a role in managing joint family property and optimising taxes. Estate planning does involve allocation and management of the assets of the individual in the event of death of a person.

Typically, inherited or ancestral property becomes HUF assets, while those out of individual earnings can stay as it is. The inheritance happens under the Hindu Succession Act, 1956, which outlines rules for asset distribution such that succession is fair and legal. This ensures protection of the interests of women and minors in the family. Also, by holding common assets under HUF, it gets perpetuated across generations.

In term of tax benefits of the HUF structure, it is treated as a separate entity. HUF also has permanent account number (PAN), and it can pay insurance premiums on behalf of the members and claim that as an expense. Like an individual, the HUF can also claim tax exemptions and rebates under the Income Tax Act, 1961. HUF offers a good engine to split family assets among several members. Thus, combining the tax slabs of the individual and the HUF, can result in substantial tax savings. Nowadays, models like trusts, family offices etc; have emerged, but the HUF still remains the traditional core of succession and estate planning.

Also read | Estate planning 101: Ten estate planning tips for senior citizens

Why tax-efficient estate planning is important

There are several reasons why tax efficient estate planning is essential for everyone who has a reasonable amount of wealth to manage and distribute. This wealth may be self-generated or inherited. It is essential to ensure that the money continues to be in safe hands, even as it takes care of the family in your absence.

The first reason to have estate planning is to ensure a proper balance between the short and the long term. Some assets are growth assets while others are income generating assets. There are loss assets, too. These have to be distributed in a legally fair way, so that everyone gets a fair share of the net worth. The second reason for estate planning is to minimise the disputes after  the death of the head of the family. If the terms are not clear or if there is no buy-in, it opens up the asset distribution to legal disputes, challenges by family members etc.

Most assets have their own set of risks. For example, financial investments are vulnerable to frauds. Real estate assets are vulnerable to squatting. All assets are vulnerable to unexplained regulatory changes. The idea of estate planning is to protect the interests of family members so that these assets are ring-fenced in a trust or a similar legal entity. This reduces chances of third party claims or legal confiscation. This is important for core needs like education, maintenance etc. More importantly, such structure also help in tax optimisation through methods such as trust creation, asset segregation, tax-free gifting, charitable contributions etc. This preserves value much better in the long run.

One of the problems we have seen in many family business structures over time is the eventual split. This can be avoided through skilled continuity plan that spans multiple generations. This does not close the door to disputes, but reduces the probability.

To sum up, the essence of estate planning is to identify the net assets of the family and use a legal structure to ensure continuity of wealth for as many future generations as possible.

Within the gamut of financial planners, we have qualified estate planners who take care of such detailed plans, including the legal structures, implementation, and the monitoring. For a tax efficient inheritance structure, the earlier you start, the better it is!