Unlocking The Power of Structured Life Insurance: A Foreign Resident’s Guide To Estate Tax Planning In Japan

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Navigating the intricate realm of estate planning can be a challenge, especially when living in Japan. Japanese inheritance taxes are notoriously high, reaching as much as 55%. This can mean a significant reduction in the wealth that you’ve built before it passes on to your loved ones. Fortunately, structured life insurance can help you mitigate the impact of Japan’s inheritance tax. So, how do families use insurance to plan for, and reduce tax? 

Understanding The Japanese Inheritance Tax System

 Foreign people living in Japan often come from countries with very different estate and inheritance tax laws. Many countries levy estate tax, rather than inheritance tax, and often offer high tax exemptions on estate assets. Some countries don’t levy death taxes at all.

Understanding The Japanese Inheritance Tax System Here are a few examples of non-Japanese death tax systems:

  • -United States: The US imposes an estate tax rather than an inheritance tax, meaning the tax is paid by the estate before assets are distributed to the heirs. As of 2023, the federal estate tax rate can be up to 40% but only applies to estates exceeding $12.92 million in value. Some individual states also impose their own estate or inheritance taxes.
  • -United Kingdom: The UK has an inheritance tax of 40% on estates above £325,000, but transfers between spouses or civil partners are typically exempt. There are also reliefs and exemptions for business and agricultural property.
  • -Germany: Germany imposes an inheritance tax with rates varying between 7% and 50% depending on the amount inherited and the relationship between the deceased and the inheritor. There are tax-free allowances that depend on the relationship as well.
  • -Australia: Australia does not impose any inheritance or estate taxes.

(Note: tax laws can change frequently, and this information is based on tax system information available up to 2023.) 

Japan’s inheritance tax, or “sōzokuzei – 相続税”, system is distinct from other countries’ systems in several ways. It is a national tax imposed on individuals who inherit money or property from a deceased person. The tax rate ranges from 10% to 55% after deducting an exemption of ¥30 million + ¥6 million per heir from the estate.

Here are some of the key factors of Japan’s inheritance tax system and how they differ from other countries:

estate planning can be a challenge, especially when living in Japan
  • -High tax rates: Japan has one of the highest inheritance tax rates globally. The tax bracket of 55% is applied to inheritances exceeding 600 million yen. The tax rate depends on the relationship between the deceased and the inheritor, and the tax-free threshold also varies accordingly.
  • -Worldwide assets: Japan imposes inheritance tax on worldwide assets if the deceased or the inheritor has been a resident in Japan at any point within the past 10 years. This is different from many countries that only tax assets located within their own jurisdiction.
  • -Split taxation: In Japan, inheritance tax is split among the heirs according to their share of the inheritance. This means that each heir’s inheritance tax responsibility is calculated separately according to the portion of the total assets that the heir receives. This is in contrast to some countries where the estate itself pays the tax before distribution to the heirs (this is often called an “estate tax”).
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Foreign people in Japan often make the mistake of overlooking the differences in these death tax laws. This can be a detrimental mistake that costs their families a significant amount of the wealth they’ve worked so hard to accumulate. If you want to keep this from happening to your family, it is crucial to understand the laws that apply to inheritance tax obligations– and specifically for Japan, the beneficiaries of the inheritance. 

Who Has To Pay Inheritance Tax In Japan?

Who Has To Pay Inheritance Tax In Japan? Japan’s inheritance tax applies to overseas inheritances involving Japanese nationals with residency in Japan within the last 10 years. It also applies to long-term residents, permanent residents, and spouses or children of permanent residents or Japanese nationals. 

As of 2017, transfers of overseas inheritances between “temporary foreigners” are exempt from Japanese inheritance tax. Temporary foreigners are foreign nationals holding a Table 1 visa and have had residency in Japan for no more than 10 years out of the 15 years preceding the inheritance event.

The “5-year tail” rule, in effect between April 1st, 2017, and April 1st, 2018, stated that transfers of worldwide assets to certain foreign nationals with 10 or more years of residency in Japan would still be subject to Japanese inheritance tax for up to 5 years after leaving Japan permanently. 

This rule only applies to inheritances occurring between the dates of enactment and repeal. Additionally, temporary foreigners must not return to Japan within two years of departure; otherwise, overseas inheritances may still be subject to Japanese inheritance tax.

What Type Of Property And Assets Are Subject To Japanese Inheritance Tax?

All heirs are fully liable to pay inheritance tax on “property” (assets) located in Japan and any property acquired outside of Japan. Inheritance tax is also imposed on foreign property if the decedent lives in Japan. Even non-Japanese heirs who live outside of Japan are subject to inheritance tax if the decedent lives in Japan. 

Inheritance tax debts must be filed and paid in one lump sum within 10 months of the date of death, with severe penalties for late payment or non-payment. Payments can be made at a tax office, post office, or through a lawyer or local tax representative.

Conventional Estate Tax Planning Approaches in Japan

Conventional Japanese estate planning is complicated, expensive, and ordinarily reserved for the ultra-wealthy. These techniques commonly use corporations, trusts, and foundations. Trusts and foundations help estate planners avoid inheritance tax by facilitating access to the assets via other means, but these options come with many limitations, such as:

Conventional Estate Planning Approaches in Japan
  • -High complexity: Estate planning using companies, trusts, foundations, and other legal structures can be highly complex and require significant expertise to navigate. This complexity can make it difficult for non-experts to effectively plan their estates and may require the assistance of costly professional advisors.
  • -High costs: The costs of setting up and maintaining legal structures for estate planning purposes can be very high, particularly for trusts and foundations. This can make these options prohibitive for families without a significant amount of wealth.
  • -Limited accessibility: Traditional estate planning strategies using companies, trusts, and foundations are generally only available to those with significant wealth and assets. This means that many families may not be able to take advantage of these strategies to minimize their inheritance tax liabilities.
  • -Regulatory restrictions: The use of certain estate planning strategies, may be subject to regulatory restrictions that limit their effectiveness or increase their complexity and costs in Japan.
  • -Limited flexibility: Once a legal structure is established for estate planning purposes, it can be difficult to make changes or adjust the strategy as circumstances change. This lack of flexibility can be a significant limitation for families who wish to adapt their estate plans over time.

These challenges make the use of trusts and foundations inaccessible for most families. Fortunately, there are other options in Japan, even if you are not ultra-wealthy.

Life Insurance As An Estate Planning Tool In Japan

One common strategy to offset Japan’s inheritance tax liabilities is incorporating life insurance into your plan. Life insurance is an effective method to counteract the impact of Japan’s inheritance tax on the wealth you wish to leave behind. By setting up a whole-of-life insurance policy, you can guarantee a predetermined payout to your chosen beneficiaries upon your death.

The goal is to ensure the “death benefit” (the payout amount) is equal to or slightly greater than the tax liability your beneficiaries will owe. This approach prevents them from having to sell family assets to cover the tax bill. Essentially, whole-of-life insurance pre-pays this bill and guarantees that the wealth you have accumulated will remain with your family after your passing.

Life Insurance as an Estate Planning Tool in Japan

To set up life insurance in Japan for estate and inheritance tax planning, one might do the following:

  1. 1. Research Japanese insurance providers and their whole of life insurance policies, or consult with a financial adviser knowledgeable about the Japanese market.
  2. 2. Assess your estate value, including assets like cash, real estate, stocks, bonds, and funds, to determine the potential inheritance tax liability for your beneficiaries.
  3. 3. Choose a whole-of-life insurance policy with a death benefit that matches or exceeds the anticipated tax liability.
  4. 4. Name your beneficiaries, ensuring that they are clearly defined in the policy.
  5. 5. Regularly review your policy and estate value to adjust the coverage as needed, accommodating changes in your financial situation or tax laws.

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Case Study: Leveraging Life Insurance For Japanese Inheritance Tax Planning

Michael Johnson resides in Japan with his wife, Yumi Johnson, and their two children, Aiko and Ken. As the main income earner for the family, Michael’s estate consists of the following: Case Study: Leveraging Life Insurance for Estate Planning

  • -House in Setagaya: 100,000,000 JPY
  • -Apartment in London: 80,000,000 JPY
  • -Private Pension account: 50,000,000 JPY
  • -Bank deposits: 30,000,000 JPY
  • -Investment account: 25,000,000 JPY
  • -Current total: 285,000,000 JPY

Michael, aged 45, saves/invests an additional 10,000,000 JPY annually. Assuming constant savings until retirement at 65, he will accumulate an extra 200,000,000 JPY, bringing his estate’s total value to 485,000,000 JPY at death. He plans to distribute 50% of his assets to Yumi, with the remaining 50% shared equally between Aiko and Ken.

The Johnson family consults their financial adviser to help determine a strategy for efficient wealth transfer – being mindful of, and minimising tax friction for their children when they inherit. The adviser recommends using a whole-of-life insurance policy to offset the inheritance tax. Michael enrolls in suitable coverage within a month, with a death benefit set at 50,000,000 JPY. This sum ensures that the family receives 30,000,000 JPY to cover the tax bill on the inheritance while also accounting for taxes on the life insurance proceeds.

Outcome:

By purchasing a whole-of-life international life insurance policy, Michael successfully offsets the inheritance tax.

The 50,000,000 JPY death benefit provides enough cash to pay the tax on life insurance proceeds and the tax bill from the estate. Yumi and the children inherit Michael’s estate intact, along with some emergency cash.

By using this strategy, the Johnson family benefits by:

  • -Retaining all of their wealth.
  • -Freeing the beneficiaries from having to sell off family assets.
  • -Establishing a quick solution that requires no further attention.
  • -Freeing the family from having to deal with legal changes related to more sophisticated asset-owning structures.
  • -Establishing the insurance company’s obligation to the family through a legally outlined contract with no relation to, or dependence upon any form of investment.

Selecting the Right Structured Life Insurance Product As A Japan Resident

There are many options for international life insurance in Japan, and selecting the right one for inheritance tax planning purposes can be a challenge. Consulting a financial adviser can help you avoid detrimental mistakes. Due to their expertise in navigating the country’s unique financial landscape, they can recommend suitable products tailored to your specific needs and goals. Their guidance ensures that your estate planning efforts are comprehensive, effective, and compliant with Japanese laws, ultimately safeguarding your family’s financial future.

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