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 in the way most foreigners are familiar, and any structures that may have been appropriate in your country of origin are likely of no use in Japan.
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 Japan 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
Japan Inheritance Tax Rates
John wants Mariko to receive 50% of his assets with the remaining 50% being split equally among his two children. In accordance with Japanese succession rules, the total inheritance tax liability would be calculated as follows:
|Taxable amount||Tax rate||Tax deduction|
In this simplified example the surviving spouse’s total tax bill would be negated by all the standard deductions available to a spouse.
However, in this simplified example the children’s tax liability will be 28,500,000 JPY, each.
What Happens Next
The family now has a total tax bill of approx. 57,000,000 JPY. Mariko cannot sell the family home because they live there. John’s immediate liquid assets consisted of his bank deposits:
Bank deposits: 30,000,000 JPY
Shortfall: -27,000,000 JPY
Mariko inevitably has to sell the apartment overseas in London, or sell off investments from within the brokerage account in order to free up the necessary funds to pay the tax bill. Having to sell off investments in a hurry could lead to unnecessary losses even in a good market, and severe losses during not-so-favorable market timing. That, or she could set up a bank loan against the family home in Tokyo to produce the shortfall of 27,000,000 JPY to pay the tax office. Even in this scenario, the family will be left without any remaining emergency cash fund, and may find themselves in another difficult financial situation if something else were to come up unexpectedly.
In the unfortunate event that both Mariko and John were to pass away, such as in a car accident, the family’s estate would not be able to take into account the large spousal tax deductions. The children would inherit the full estate, and face a tax bill of over 130,000,000 JPY.
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:
– The family needs to receive 30,000,000 JPY when John dies to pay the tax bill [based on the assumptions made above]
– The family will be paying tax on the death benefit received from the life insurance policy, so the NET PROCEEDS have to total 30,000,000
– John signs up for a whole-of-life international life insurance policy while in Japan to offset inheritance tax
– The death benefit is set at 50,000,000 JPY (or currency equivalent – most people choose USD)
– This provides enough cash to pay the tax on the life insurance proceeds, as well as the tax bill from the rest of the estate
– Mariko and the children are left with John’s estate intact and with a small amount of emergency cash
The Benefits of using Life Insurance for Japan Inheritance Tax:
- The Smith family did not have to lose a substantial portion of its wealth
- The beneficiaries were not forced to sell off family assets
- The solution is set up and concluded in a short amount of time and 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