So you now know that you are going to be exposed to Japanese inheritance tax (IHT) on your assets- moreover, you know that your family are going to be left holding a substantial tax bill when you die, so what can be done to plan for it?
If you have accumulated substantial wealth, then you may have access to options that remove your inheritance tax liability outright by ensuring that the assets do not transfer on your death. Any assets which are not legally owned by you do not move to your nominated beneficiaries upon your death and as such your beneficiaries do not have any tax liability; a traditional example of such a structure would be the Beneficiary Trust. Unfortunately for expat Japan residents, Japan’s legal system does not acknowledge trusts, and any structures that may have been appropriate in your country of origin are likely of no use.
If the size of your estate (i.e the total value of all of your assets; cash, real estate, stocks, bonds, funds etc.) is such that you are only just reaching into the tax-bands for inheritance tax, or if you just want to keep your planning simple, the best method to plan for inheritance tax is with life insurance. By setting up a whole of life insurance policy (WOL) you are able to engineer a guaranteed pay-out of a pre-determined amount of money, paid to your chosen beneficiaries. The idea is that the “death benefit” (i.e the amount of money paid out) should be equal in size, or slightly larger than the amount of tax owed by your beneficiaries. The benefit of this is that they do not have to sell the family assets to release the money required to pay the tax office. Without this, family members may be forced to sell-off assets at a time whereby they realise a loss (e.g during a down-market, for stocks) or for a depressed price (for real estate assets, when buyers are outnumbered by sellers). Whole of life insurance is a way to effectively pre-pay this bill, and ensure that everything you have worked hard for and accumulated will stay in the hands of your family after you are gone.
An Expat Inheritance Tax Planning Case Study
Meet the Smith family. John Smith lives with his wife Mariko Smith and their two children, Miya and Leo. John is the primary income earner for the household and has lived in Japan for 10 years. His current estate consists of the following:
– House in Setagaya
value: 100,000,000 JPY
– Apartment in London
value: 80,000,000 JPY
– Private Pension account
value: 50,000,000 JPY
– Bank deposits
value: 30,000,000 JPY
– Investment account
Sum total at present: 285,000,000 JPY
Now, John usually saves/invests an additional 10,000,000 JPY every year. We need to include this in our estimation to ensure that the appropriate amount of death benefit is selected. Methods hereafter are case by case and there is no “correct” way to do it, as it revolves around things that we cannot predict, i.e when somebody will die, expenditure, and what annual returns they will receive on their investments.
John is 45 at present and has expressed that despite leading a relatively healthy lifestyle, he does not believe that he will live past 85. If we work on the basis that John’s annual savings will remain constant until statutory retirement age at 65, this adds an extra 200,000,000 JPY in wealth to his estate. Of course in reality, John will have other non-discretionary expenses to meet during this period which will affect his ability to save 10,000,000 p.a, like university expenses and other miscellaneous costs, but we shall look at this as being offset by his investments. If we choose to not include investment growth, we feel that these “returns”, which would be substantial over two decades, will more than likely cover the gaps in annual savings during the “expensive years”.
Sum total at death: 485,000,000 JPY
Japanese Inheritance Tax Rates
John’s last will and testament states that everything is to go to his wife Mariko is she outlives him, and thereafter she will be able to give money to the children as required- ultimately, with the estate being divided up between their children Miya and Leo when Mariko dies. At present, there is an exemption for the first 160,000,000 JPY in value commuted to a surviving spouse, with an extra 10,000,000 in allowance per child. Resultantly, the tax free allowance for the Smith family is 180,000,000 JPY. Anything beyond this will be taxed at the following rates:
|Taxable amount||Tax rate||Tax deduction|
After subtracting the spousal allowance of 180,000,000 JPY from the total value of the estate (485,000,000 JPY) the remaining portion of the estate which will be exposed to inheritance tax is 305,000,000 JPY. As per the table, there is a deduction of 42,000,000 JPY so we can calculate the IHT bill as follows:
( 305,000,000 – 42,000,000 ) x 50% = 131,500,000 JPY
What Happens Next
Mariko now has a bill for 131,500,000 JPY from the tax office. Mariko cannot sell the family home because they live there. John’s liquid assets, if sold off add up to:
Bank deposits: 30 mln JPY
Investment account: 25 mln JPY
Private pension account: 50 mln JPY
TOTAL: 105,000,00 JPY
Shortfall: -26,500,000 JPY
Mariko inevitably has to sell the apartment overseas in London to free up the necessary funds to pay the tax bill. That, or set up a bank loan against the family home in Tokyo to produce the shortfall of 26,500,000 JPY to pay the tax office. The Smith family has essentially lost 50% of its wealth because it did not plan. A very expensive and unnecessary lesson in financial planning.
What Should Have Happened
John and Mariko should have asked their financial adviser what they can do to ensure that their wealth passes between them efficiently and without avoidable expense. The financial adviser would have explained the concept of using whole of life insurance and John could have been signed up for appropriate cover within 30 days. The process would have looked like this:
– Mariko needs to receive 131,500,000 JPY when John dies to pay the tax bill [based on the assumptions made above]
– Mariko will be paying tax on the death benefit received from the life insurance policy, so the NET PROCEEDS have to total 131,500,000 – what is the required gross sum assured?
To ensure that the proceeds are treated as income and not a gift (which could be taxed at a higher rate, with less relief), Mariko will be paying the premiums for the life insurance. Any proceeds from John’s life insurance will be taxed at the marginal rates shown in the table.
– John signs up for a whole-of-life international life insurance policy
– The death benefit is set at 170,000,000 JPY (or currency equivalent – most people choose USD)
– Mariko pays the monthly premiums
– When John dies, the insurance company pays Mariko 170,000,000 JPY
– Mariko has an income tax bill of 34,041,600 JPY (based on having no other income or deductibles at that time)
– Mariko is left with 135,958,400 JPY
– Mariko pays the inheritance tax bill for receiving John’s estate with the life insurance money and has 4,458,400 JPY left over
- The Smith family did not have to lose 50% of its wealth
- The beneficiaries were not forced to sell off family assets
- The solution is set up and concluded on day one with no further attention required
- The family does not have to keep up to date with any changes in law relating to more sophisticated asset-owning structures
- There is no relation to any form of investment and the obligation of the insurance company to the family is legally outlined in contract
[ Sources ]
– Japan National Tax Agency
– KPMG Japan