“From clogs to clogs in three generations” is an old saying that has been proven to be true over the years. Research has shown that 70% of wealthy families lose their wealth by the second generation and 90% by the third.
This is also borne out by surveys that show the list of the UK’s 1000 wealthiest families and individuals is a “revolving door” (“The Sunday Times Rich List”, April 2017).
The old saying has stood the test of time with the growing complexity in tax, estate planning and exchange controls. These add to the list of potential pitfalls that end up eroding the passage of wealth between generations.
Generations and siblings of wealthy families are also nowadays more likely to find themselves spread-out across different countries, with regulation in different jurisdictions adding to the complexity, while the structure of families themselves is changing: second marriages mean second groups of children.
So how does a family ensure that wealth is not lost over the generations?
Alexandra Nortier, joint head of wealth management at Investec Wealth & Investment, explains that it’s important for families to have meaningful conversations about wealth and to start as early as possible: “What we’ve found is that that the families that transfer wealth positively, are the ones that start the conversation [about wealth] early. They educate and they mentor.”
Marc Romberg, joint head of wealth management at Investec Wealth & Investment, spells out some of the reasons wealth doesn’t make it to the third generation. One reason is simply fragmentation: the inheritance is spread out across a broad range of heirs.
Poor returns on investments or a lack of interest by heirs in managing the family wealth are others.
Stewards of the family wealth may end up taking excessive risks or, alternatively, invest in very low-risk investments and find the wealth being eroded by inflation. Poor tax planning is can also erode wealth while conflict can also lead to poor decisions.
“But the lack of strategic planning, mainly around succession planning, is perhaps the main reason,” argues Romberg. This requires open conversation between family members as a start.
Keeping the conversation going
As part of a process to gauge the views of Investec clients around intergenerational wealth planning, we polled 1331 clients around the country. The results were revealing and we unpack some of the findings below.
What is more important to you, a) ensuring you leave your heirs better off, or b) contributing to your community, society at large or the environment?
A = 76%
B = 24%
It’s clear our clients are keen to leave their heirs in a comfortable position, but there is also a keenness to contribute to making the world a better place.
This imperative may grow in future years, especially in the light of worries about global warming, poverty and biodiversity. Romberg points out that for Millennials and Generation Z (those born in the early 1980s and later), “it’s not just about financial profits. So we are likely to see greater focus on impact investing from here on”.
But the two goals need not be mutually exclusive. With proper planning, a wealthy family should be able to serve both imperatives.
Do you have family discussions around succession, wealth distribution and philosophies when it comes to dealing with money?
Yes = 59%
No = 41%
How prepared do you feel you are to transfer your wealth to the next generation?
Very = 21%
Moderately = 41%
Slightly = 24%
Not at all = 14%
How prepared do you feel the next generation is to handle your wealth transfer?
Very = 11%
Moderately = 24%
Slightly = 29%
Not at all = 36%
The above questions deal with some of the structures and agreements that families put together to manage their wealth. A well-drafted will is an obvious starting point, but as well as being up-to-date, a will needs to take into account the different tax regimes where assets reside, and any change to legislation in the different jurisdictions (see below for more detail).
Lizzie Fick of the Investec Wealth & Investment fiduciary and tax team says trusts are a useful succession planning tool and can be helpful in protecting beneficiaries and instilling core values.
Nonetheless, trusts do face a number of challenges on the tax front that founders need to be aware of.
Many wealthy families have adopted a family constitution as a way of instilling values and managing conflict. A family constitution is a non-binding document that can take many forms but is a robust way to manage the wealth transfer and build consensus around key issues, such as:
- Who runs the family business
- Key ethical and moral issues
- Investment strategies (which can also include ethical issues, such as socially responsible investments)
- The family’s philanthropic vision
“The family constitution can be as detailed and formal as you like, or short and simple, provided it clarifies and supports the family’s key philosophies,” says Nortier.
What is the current geographic split of your investable asset base (SA vs offshore)?
100% SA investments = 20%
70% SA/30% offshore = 44%
50% SA/50% offshore = 19%
More than 50% offshore = 17%
This question not only speaks to the importance of a well-diversified investment portfolio – of which offshore investments are a key component – but also the challenges of complex modern families and where their assets live.
“Family units are becoming more complex and more international, with beneficiaries and assets in different countries,” says Rene van Zyl of the Investec Wealth & Investment fiduciary and tax team.
Blended families add to that complexity. Where family members reside and where assets are situated, significantly impact how best to preserve family wealth and this must be taken into consideration when drafting a will.”
The once sacred principle of banking-secrecy saw its demise thanks to US Foreign Account Tax Compliance Act (FATCA) and a FATCA-like regulation known as the Common Reporting Standard (CRS). CRS requires automatic reporting between countries on a mutually beneficial basis.
The implementation of the CRS means that SARS, more than likely, will discover any undeclared offshore funds, whether they are held in complex structures or not. They now automatically gain access to financial information relating to SA tax residents’ offshore dealings, and their offshore structures.
Situs is Latin for position or site. On death, South African residents are liable for estate duty based on their worldwide assets. Estate duty is currently levied at a rate of 20% in the case of an estate less than R30-million, and at a rate of 25% on the value above R30-million, but there are also situs taxes levied in the
US, UK and elsewhere for assets held there. “It’s vital that the executor understands the different requirements in different countries,” says van Zyl. Also important is for families to plan accordingly and to get the right advice.
“It’s really important to have a family road map to deal with all of the tax and estate planning complexities,” says Fick. “A family constitution, along with well-drafted wills and trusts that take into account all of the legal possibilities, are essential.”