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How to Protect Your Family Wealth through the Generations

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David Truman

David Truman – Private Client Partner

A recent study indicated that the majority of family fortunes disappear within just three generations.

The reasons for this are varied. At their simplest, the Inheritance Tax (IHT) charge on death, currently 40% of chargeable assets, can deplete wealth quickly. Add to this where later generations no longer have the expertise, drive or flair that created the original wealth, there is a good chance the money will be lost, spent or invested badly.

So how do you protect the wealth built up as it passes down the family? This has to be down to both good practical foresight and prudent wealth planning to protect the position from bad management or investment going forward.


Who should take over running of business?

Business owners should consider what will happen to the business when they retire, and whether the business is still important to them after their retirement/death. Some may feel it has served its purpose and should be sold/liquidated to provide funds for the family going forward. Many others will have an affection for their business and want it continue as a legacy or ongoing source of family wealth. The owner should be clear whether their priority is the future long term success of the business or the preservation of the family fortune.

The owner therefore needs to consider carefully who could take the business forward. Options include:

1 – Keeping it in the family

Many may like their children to carry on after them, but they may not be the best people to have full control or ownership as those children may not have the skills required or even wish to follow in their parent’s footsteps.

If the business is to continue as “family-owned” it is important to ensure future harmony. It is vital to set out clear and firm instructions as to who will lead the business and consider whether this selection of a new leader will create family issues. As above, family members may not have the experience of the owner and it is important to evaluate the talent supply and develop leaders so that they hit the ground running on transfer.

2 – Current Staff

Management may be better placed to take over. If so, owners may want to secure an experienced team and either have family as shareholders only or simply look to take out some of the value from the business for themselves and their family before handing it over.

This can be achieved by reorganisations and buybacks but careful consideration will need to be given to who is involved in the decisions going forward. This may be employees,  investors or family or a combination of any but there needs to be clear plans to set out who will run the business and who the ultimate decisions lie with to avoid future disagreements and clearly show where the new line of management falls. This may involve new share issues, partition of the business and many other possible structures to maintain a healthy and manageable business.

3 – Selling the business

If next generation owners cannot be found the decision may be made to sell the business. If so, the owner needs to develop a disposal strategy to ensure maximum wealth is extracted.


Planning for succession taxes

The Company

Shares in the company will often qualify for Business Property Relief (BPR) where the company is a trading company and this can mean that there is no charge to IHT on those shares on death, whereas unused sale proceeds (or remuneration) will be subject to tax on death.

Gifts

Gifts are the simplest way of reducing the value of the estate for IHT. However, the owner has to be happy with the loss of control and protection of that money to the donees – although without action the funds may be taxed and then pass to the beneficiary anyway.

Other Assets

Cash and other assets not qualifying for BPR such as land, investments, inheritances etc will also be liable to IHT and therefore passing on these assets prior to death may be beneficial.

The owner of the investments firstly needs to consider what they need to achieve from those assets. Depending on the income and capital needed to fund current living needs, they can then look at passing wealth on to younger family members, reducing potential tax burdens and protection of that wealth for future generations.


Do you need a family investment vehicle?

The owner may be best to assess the donee’s ability to deal with and invest money wisely and it is always best to educate the next generations on how to do this so that they are ready when eventually taking over the reins. Before that happens the owner needs to ensure the required level of control and protection are maintained but that the risk of heavy taxation is reduced. Life assurance can help cover tax liabilities, particularly whilst heirs are young but, alternatively, other structures can help to move funds out of the estate yet retain control and protection, for example family investment companies and trusts.

Family Investment Companies (FIC)

A FIC is essentially a bespoke family investment vehicle in the form of a company whose directors and shareholders are individual family members – allowing the family to determine how each member can benefit by defining the rights attaching to each class of shares in terms of income and capital.

They allow for tax efficient investment, flexibility, passing on of wealth to next generation and reduction of IHT exposure BUT retains the control over that wealth (by way of voting rights etc).

Additionally, by including children in such structures, they can gain insight into how to invest and can acquire financial knowledge, learning how to converse intelligently with professional advisors and bankers, contribute towards effective family decision-making and develop the skill and mind-set to nurture and build the family wealth.


Trusts

Trusts have been around for hundreds of years and are often now overlooked in planning but they are still a very important aspect in offering protection of funds to next and future generations.

Features include:

  • The trustees will be able to control and protect the assets, irrespective of the beneficiaries’ own personal and financial positions.
  • The trustees are under a duty to hold the property for the beneficiaries’ benefit
  • The settlor can indicate their wishes and intentions, which can be updated if required
  • Amounts up to the Nil Rate Band (currently £325,000 each) can be transferred into a discretionary trust without incurring any immediate IHT charges.
  • After 7 years, gifts into trust become ‘exempt’ from IHT and further amounts can be transferred into trust.
  • 10 yearly and exit charges may arise where the funds held in trust grow exceed nil rate band at the time of the chargeable event.

Trusts will be subject to income tax and capital gains tax but they offer a way of moving assets out of the owner’s estate for the benefit of next generations but retaining some control and, importantly, protection from wealth being spent or mis-invested by beneficiaries, and from claims on them, such as from bad marriages/divorces.


Conclusion

Planning is often considered too late, leaving no opportunity for first generation entrepreneurial/investment talent to be passed on and developed. Successive generations are unable to make good decisions and, at best, can only maintain wealth rather than continuing the growth or, at worst, lose wealth through poor investment, management, or tax planning.

To protect and preserve wealth the owners need to educate their family on wealth strategies and a sound understanding of what has made the business/family successful. They will need buy-in of those to be involved, and set out clear instructions to avoid future disputes.

Menzies are able to advise on all business and personal tax matters including business structures, wealth planning and tax and inheritance tax planning.

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David Truman - FCCA

Partner

Please get in touch with your normal Menzies contact if you would like to discuss planning opportunities in any of these areas, or alternatively contact David Truman.