Four steps to take when distributing wealth

By STUART RITCHIE

I deal with a lot of investors who not only want help to grow and preserve their wealth but distribute it to their families too. The latter part of financial planning is particularly important as family wealth can drastically decline across generations. In fact, many family fortunes rarely make it to the third generation. Which means your wealth most likely won’t reach your grandchildren. But that’s only if you don’t plan properly.

Andrew Carnegie once said: “Shirtsleeves to shirtsleeves in three generations.” The same expression is interpreted across cultures. Clogs to clogs. Rice paddy to ride paddy. Stalls to stalls. They all mean that the wealth gained in one generation will be lost by the third.

You, as the first generation, have worked hard for your money. You’ve taken the necessary steps to grow and preserve it, hopefully in a portfolio of diversified funds. With the confidence that you’ll have enough to live out your ideal retirement, you want to take what’s left of your wealth and pass it on to your children. And, hopefully, your children’s children. And their children after that so they can all get a head start in life. But how do you do that? Where do you even begin?

Before we get into it, here are some things to consider…

What’s the most important thing when it comes to distributing wealth to your family?

You might think it’s tax-efficiency or timing but it’s not. It’s education. Alongside tax efficient and timely succession and estate planning, you must educate your children about money.

Unconvinced? Consider this:

In the US, over the next 30 years, $16tn will pass to gen Y, gen X and millennials.
At the peak – predicted to be between 2031 and 2045 – 10% of the total wealth in the USA will be changing hands every 5 years.
70% of family fortunes will lose their wealth by the second generation.
Another 20% won’t make it beyond the third generation.

Without a solid foundation in financial basics, your wealth may be squandered. It may not reach your children and grandchildren, despite your best intentions.

How to educate your next generation

The good news is, there are numerous books that do a fantastic job of educating people on the world of finance. Many help people develop better financial habits. We’ve dedicated a blog post to this before.

There you’ll find Tony Robbins’ best-selling book Unshakeable along with Rescue Your Money by Ric Edelman, The 5 Mistakes Every Investor Makes by Peter Mallouk, and more. These books changed my life. And I’m confident it will do the same for you and your children. Since it’s nearing Christmas, they will make excellent gifts.

The lessons they’ll learn will be invaluable.

How to distribute your wealth fairly and tax efficiently

Everyone’s living longer than ever. That’s good news for us who have long lists of things we dream to do. But it also means that wealth is being passed on to the next generation later. When children are grown up with careers and families of their own.

So, if you have surplus wealth, making significant gifts before you die can benefit your family at a time when they most need help. In addition, it can be a tax-efficient way to distribute your wealth. On that note, here are 4 more ways to distribute your wealth fairly and tax efficiently…

1. Work out how much you can afford to give away

Work with a financial planner to develop a cash flow forecast on a worst-case-scenario basis. This will determine how much you can reasonably afford to give away now. It will add up your outgoings, make an allowance for inflation, and consider the money you might need for emergencies or even luxuries.

It should also ensure you have a strategy to pay for care in your later life, as often these are costs that go unaccounted for. Your adviser will then see how your final figure compares to your total fixed income from pensions, properties, and other income-generating investments. At the end of the process, you will know exactly how much you can afford to give away.

2. When should you distribute your wealth?

People often leave distribution too late to be tax efficient. The best time to plan a distribution strategy is as early as possible. This way, you will hopefully have many more years left. If you’re in the UK, for example, you have to live longer than 7 years after the gift’s been made, in order for it to be inheritance tax (IHT) free.

3. Who should benefit, and by how much?

This is the hardest question for most people to deal with – especially those with several children and grandchildren, or more than one marriage behind them. As uncomfortable as the idea may seem, a good way forward is to have an open conversation with your entire family, together with your financial adviser who can act as an independent professional (and, in my experience, a mediator).

However, I appreciate family dynamics are complex. Sometimes the simplest way is to give fixed amounts to any grandchildren, and then divide the rest equally between children. But, if one family member needs money more urgently than another, explaining that they are getting their inheritance upfront could be a way forward if you can’t afford to give everyone an equal share right now.

4. How to make transferring wealth as tax efficient as possible

I recently covered the topic of UK inheritance tax (IHT) in a blog post. If you survive 7 years after making a gift, it does not form part of your estate and is tax-free. If you don’t survive 7 years, then taper relief might mean the IHT charged is less than 40%. Other reliefs exist, such as business relief, and allow some assets to be passed on free of IHT or with a reduced bill.

Small gifts you make out of your normal income, such as Christmas or birthday presents are called exempted gifts and are also IHT free. Other UK exemptions exist too which you can read in full detail here, while similar exemptions exist for other countries.

Stuart Ritchie is a Chartered Financial Planner, APFS, Chartered Wealth Manager, and Chartered FCSI. Stuart works for AES International, a firm based in Dubai who specialise in helping ex-pats to invest.