Wealth Succession Planning: Leaving a Legacy
Many recent media articles have highlighted that there will be an unprecedented transfer of wealth to the boomer generation, which is already underway. Some reports estimate that the amount in Canada could approach $1 trillion by the time this transfer is finished. With such an unprecedented wealth transfer, concerns are being raised on whether the next generation is ready to deal with the wealth they stand to inherit.
One issue that is often overlooked is a succession plan for wealth. For those who own a business, the wealth transfer issues will be similar to the succession planning issues they already face. As they reach retirement, the immediate focus for business owners is transitioning the operations of their businesses to new leaders. This could take the form of a sale to third parties or employees or could involve bringing in family members to run the business.
The question is the same for any individual who has accumulated wealth over the course of their life — have I set a succession plan for my wealth? Or, put another way, what sort of legacy do I want to leave?
Why is there a concern?
A big concern among many tax and financial advisors is the lack of communication within a family when it comes to issues surrounding death and potential inheritances. Any discussion on the issue forces the parent to face their own mortality, in the context of a discussion with their children. This is a daunting exercise but open and honest discussions will generally not be as difficult as one would expect. If difficult discussions do arise, the underlying problems are often related to pre-existing issues that would need to be dealt with anyway. In fact, it is generally better to resolve difficult issues sooner rather than later, as these issues can take a life of their own when left unresolved.
From the child’s perspective, there are usually two concerns. First, many are just as motivated as their parents to avoid conversations that are perceived to be difficult. Secondly, as a potential beneficiary, it is difficult for children to initiate discussions on wealth succession. Unfortunately, even where a child is acting in the best interests of everyone, their motivation can be questioned.
Another major concern is that a child may be making significant investment and financial decisions for the first time when they inherit wealth. It will be important to invest wisely as financial or investment mistakes due to inexperience may have a high cost.
Finally, other areas should not be overlooked, such as the importance of overall financial and tax planning advice, which may be needed for the first time.
Basic Estate Planning vs. Legacy Planning
Before talking about the process in detail, it is important to draw a distinction between basic estate planning and what some have referred to as “legacy planning”. The goals of estate planning are specific, such as:
- Maximizing and preserving the value of your assets,
- Minimizing and deferring tax and other costs that will arise on your death,
- Allowing for an orderly transition of assets to your beneficiaries, and
- Providing for your dependants.
Legacy planning takes estate planning one step further by dealing with other issues, such as:
- Educating the next generation on issues surrounding wealth management,
- Improving communications within your family, ensuring that you share your intentions, hopes and concerns along with specific instructions,
- Setting some family values and perhaps even a mission statement, and
- Establishing philanthropic goals (where desired).
Although some might see this sort of process as setting the stage for “ruling from the grave”, this process may help avoid this issue. For example, where an individual has accumulated wealth and is concerned that the next generation may not properly plan for financial issues (including tax) or make unwise investment decisions, one approach is to try to control this issue by using a trust. Under such an approach, investment decisions are deferred to trustees and restrictions may be placed on the ability of the beneficiaries to access income and capital from the trust. One negative by-product of such planning can be the reinforcement of a child’s perception that a parent doesn’t trust them, as they continue to receive “an allowance” well into their adult life.
The idea behind legacy planning is that adverse events can also be managed by way of shared values and increasing the knowledge level of your family. This allows them to make decisions for themselves while understanding how your wealth was established and taking your values and desires into account.
That said, it is important to remember that we are not questioning the value of trusts. They are an important tool to safeguard the interests of beneficiaries. For example, a trust is critical where a family member is simply not capable of managing their inheritance due to an infirmity. Trusts can also produce substantial tax savings, especially when combined with an incorporated owner-managed business.
Legacy planning helps create a balance between safeguarding specific risks and reducing taxes while allowing your family to deal with your wealth as adults.
Where do you begin?
Before you develop a plan, you’ll need to gather some information, and give thought to a number of key questions (see box below). The goal is to come to some conclusions on important issues and draw a clear picture of your financial and non-financial goals.
Key Questions and Decisions
- What am I most proud of accomplishing over the course of my life?
- What are the top 3 impressions that I want my family and/or my community to associate with me?
- Is my family prepared to assume full responsibility for the business and financial matters currently under my management? If not, could they with specific learning and development?
- Does my family have the skills and the confidence to ask the questions and make good decisions? If not, could they with more information or development?
- Does my family know all of my key trusted advisors? Are they comfortable with them?
- If I own a business, do family members have the interest and ability to take over the business?
- Which family members will share in my estate (spouse, children and possibly grandchildren)? Is there an extended family?
- Have I provided financial assistance to some family members more than others in the past? Should I consider this when determining how my wealth will be shared?
- Where a vacation property is owned, do we want to keep this in the family or should it be sold?
- Do I have philanthropic interests?
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The second part of the process is to take this information, and develop a plan that will meet your goals while dealing with your financial situation. For example, if you have complex financial holdings, likely beyond the abilities of family members to manage, your plan should deal with this. Possible alternatives could be simplification or ensuring your family has access to trusted advisors.
As the plan is developed, key components may include:
- Setting a process for open communication (including how your wealth will be divided and why),
- Building financial and investment knowledge and skills,
- A will, which is reviewed and updated regularly,
- Assessing whether your family will be capable of managing your financial affairs when the time comes that you can’t, and determining the best course of action if they will need help,
- A determination of the tax issues that will arise on death, and setting a plan in advance,
- Reviewing the tax planning alternatives available to you, including family trusts, testamentary trusts arising after death and other ideas,
- Reviewing and addressing your insurance and retirement needs,
- Where a business is owned, ensuring that you have a specific succession plan for the business,
- Where a vacation property will be retained in the family, a plan for the use of this property, and
- If you have philanthropic interests, setting a plan to identify the charities you want to benefit while ensuring the plan takes advantage of the significant tax incentives that are available.
We have discussed many issues and the decisions you need to make may seem overwhelming. Remember that planning for your legacy is a process and these issues are best dealt with over time with the help of your BDO advisor.
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