Building and Transferring Family Wealth over Generations – Basics of Wealth Planning
Wealth planning defines and implements the wealth strategy across life cycles and generations. A comprehensive and holistic wealth planning strategy will, among others, take care of tax and succession planning, asset protection, liquidity planning, and sometimes even wealth growth strategies of the total wealth of a family. This article will provide an overview and guidance on the process together with an overview of the most frequently used tools to implement a comprehensive wealth planning strategy, in order to build and transfer family wealth over generations.
1. Establish an Inventory
The first step towards implementing a comprehensive wealth planning strategy is to establish an inventory of all assets and liabilities of a family in order to analyze the situation properly and discuss the detailed needs with the family members. The inventory will give an overview of the assets located in the domicile country(ies) of the family members and abroad. All asset classes are relevant, such as bank accounts, real estate holdings, participations in businesses, intellectual property, cryptocurrency, pension funds, commodities, etc. Some of these assets may come with liabilities such as Lombard loans, mortgages, pledges and the like. There may however also be stand-alone liabilities such as uncovered loans.
It is important to have a etailed overview of each and every asset and liability in terms of ownership: who is the owner, how is the ownership structure (i.e. are bank accounts or real estate held via a structure), are there any restrictions on the ownership such as co-ownership or other contractual restrictions, restrictions from matrimonial property law, usufruct, etc.?
This may be a good opportunity to ensure that all assets are formally and properly registered where applicable and that all legal documents and titles are kept and filed adequately. Recently electronic wealth platforms have been created which enable the electronic records to be kept and ensure tailored availability together with regularly updated values of the assets for the family members, and even for their service providers if required.
2. Some Tools
a) Wills
For most assets, globally the laws of the last legal residency of the deceased will be applicable to the estate of the deceased. Real estate held abroad is the most frequent exception, however if held directly by a deceased foreigner, local laws will usually refer to the laws of the last residency of the deceased person. As international inheritance processes can be very cumbersome, expensive and time-consuming, many individuals prefer to avoid them by establishing structures to avoid them, such as trusts, family foundations, insurance contracts and the like. A will can also avoid legal disputes after death, as it generates additional legal certainty.
If it is considered that the succession laws of the jurisdictions of domicile are complete enough, there is no need to prepare a will. For high net-worth families however a will is almost always strongly recommendable, given the choices available to adapt the inheritance process to the individual needs of the family and the international exposure in terms of assets and often also family members. Likewise it is advisable for families with complex situations, because if family life is complex now, how will it look when there is wealth to be distributed? A will will also enable individuals to tailor their succession to their needs in terms of distribution of wealth, taking care of minors and/or other vulnerable family members, for example with an incapacity or elderly family members. Depending on the jurisdiction, a testator may choose his own executor, and/or a guardian for minor heirs. A will may also reduce the risk of legal claims, and will often reduce the estate administration costs when drafted accordingly. In the case of transferring a business, a will may give the opportunity to address business continuity topics such as choice of future management, for example when the testator owns and runs the family business at the same time. Finally in certain jurisdictions testators may have tax advantages by stipulating the set-up of a testamentary trust in their will. Depending on the testator’s jurisdiction, forced heirship rules may be applicable to the estate. In some of those jurisdictions it may however also be possible to plan around some of those forced heirship restrictions through the use of trusts, foundations or life insurance contracts. In certain other jurisdictions again, testamentary contracts may be another succession planning tool which may even provide certain tax planning opportunities, for example in connection with repurchase agreements.
b) Power of Appointment
A power of appointment is issued by a testator or the settlor of a trust and permits a power holder to direct where his or her interest in an estate or trust may go to. A general power of appointment enables the power holder to direct his or her share in a will or trust to any individual or legal entity, including to the power holder him- or herself, his or her estate or even creditors of the power holder and/or his or her estate. A limited power of appointment permits a power holder to direct his or her share to a specific class of beneficiaries such as his descendants, but not to the power holder him- or herself, his or her estate or his or her creditors or the ones of his or her estate.
c) Living Will or lasting Power of Attorney
A living will is made to take care of an individual and his/her family’s needs, when the person becomes incapacitated. Usually a power of attorney is broader than a living will. Depending on the laws applicable to the document, it may contain advance decisions on possible types of medical treatments, but also on how the principal would want his or her financial affairs to be treated during incapacity, including management continuity of the family held businesses.
d) Prenuptial and matrimonial Agreements
Prenuptial agreements are an asset protection tool normally ensuring separation of pre-matrimonial assets. In some cases it can also be used for tax planning or even to provide for certain family members in the future. Matrimonial agreements will, inter alia, normally define the rights of the parties concerning the assets of the couple. There can also be cohabitation agreements and –following a divorce – post-nuptial agreements.
e) Usufruct
In many – normally civil law – jurisdictions there is the legal mechanism of usufruct. The right to usufruct normally consists of using an asset or the right to the profits derived from an asset, whereby the ownership of the property itself is with somebody else. Usufruct can be a way to partially transfer property during lifetime to the next generation and a tool for tax planning when the usufructuary for example lives in a jurisdiction where usufruct is not taxed.
f) Buy-Sell Agreements
A buy-sell agreement often is a contract between co-owners of a closely held business setting out how and when equity interests are to be transferred to the remaining co-owners if and when a certain event such as death or divorce occurs. This can be a stand-alone agreement or it can be integrated into a shareholder agreement.
Then again, a spouse may hold interests in a closely held family business and a buy-sell agreement may provide agreements in connection to passing or divorce of that spouse. The agreement would then provide a mechanism to buy out the other spouse. Here again the agreement can be a standalone or it can be integrated into a prenuptial agreement.
Buy-sell agreements are regularly used in asset protection, and from time to time in tax planning.
g) Double Tax Treaties
Double tax treaties are agreements between two countries to prevent the double taxation of private individuals and legal entities with an international nexus concerning taxation of income and capital. They will regularly be applicable in cases where individuals hold assets in a different jurisdiction than the one in which they are domiciled. They may also be applicable when an heir lives in a different jurisdiction than the deceased. By holding foreign investments through legal entities of third countries with more favorable double tax treaties with the omicile country and the country of the investment, the overall taxation may be reduced.
h) Investment Protection Treaties
Investment protection treaties can be an important asset protection tool. The purpose is to generate international law protection against non-commercial (for example political and/or legal) risks associated with investments for individuals and corporate investors. The contracting parties are countries and most of the agreements are bilateral. Depending on the applicable agreement, the protection includes state discrimination against foreign investors, unlawful expropriation or unjustified restrictions on payments and capital flows. There may also be an obligation of jurisdictions to treat investments made by investors of the contracting jurisdiction ‘fairly and equitably‘.
i) Companies
Domestic companies may be useful to limit liability and generate tax planning effects. Foreign companies (such as holding structures, but also private investment companies) may also limit liability and generate access to favorable double tax treaty jurisdictions as well as other tax planning opportunities.
j) Trusts
A trust is a structure whereby a person (the ‘settlor’) transfers the enjoyment of assets to a group of individuals (the ‘beneficiaries’) if required also himself, while the control and decisions on the administration of those assets lie with others (the ‘trustees’). Because trusts can generate higher flexibility than wills (for example staggered distributions) but also avoid often cumbersome, expensive and time-consuming probate procedures, trusts are often used for succession planning, especially in cases of families with minors, disabilities and when transferring family businesses. Trusts can also be structured to obtain important tax planning and/or asset protection effects. There are different structures available for planning, such as domestic trusts (in many countries) and offshore trusts. In order to obtain certai n specific planning effects, trusts may be irrevocable, for pure succession planning however they may also be revocable.
k) Family Foundations (also called Private Interest Foundations)
Family foundations are legal entities holding funds normally dedicated to take care of and to transfer assets to members of a specific family. Compared to a simple will, a foundation will enable the founder to pass the assets to the next generation with more flexibility, such as staggered distributions. Given this purpose, the legal framework in jurisdictions regulating amily foundations will usually provide them with a high level of confidentiality.
l) Charitable Foundation
Charitable foundations are legal entities holding funds normally dedicated to take care of one or more specific non-profitable purpose(s). Some jurisdictions provide a considerable level of control to the founder or his/her family over the management of these charitable foundations, as well as high levels of confidentiality. Other jurisdictions position themselves as being more intrusive in terms of transparency but provide state control ensuring that the statutes of the foundations are meticulously followed. The amount of tax deduction achieved by a founder will regularly also be a major factor when choosing the jurisdiction of a charitable foundation.
m) Private Placement Funds, Umbrella Funds
A private placement fund is a collective investment scheme set-up for and owned by a pre-selected group of investors (often a family), whereby their shares are not available on the open market. An umbrella fund is also a collective investment scheme set-up for and owned by a pre-selected group of investors (often a family), whereby their shares are not available on the open market, and the respective sub-funds of the umbrella fund will normally have segregated liability. Both private placement funds and umbrella funds may be used for limiting liability but also for tax planning.
n) Private Placement Life Insurance
Private placement life insurance is a life insurance contract based on which a life insurance company usually holds a segregated investment portfolio at a bank (or broker-dealer) for a specific life insurance relationship. Upon the death of the insured person the portfolio (plus proceeds) are distributed to the beneficiaries together with the amount of insurance coverage which can be a fixed amount or a percentage of the value of the portfolio at the moment of death of the insured. Private placement life insurance contracts are regularly used for succession planning but may also have uses in tax planning and have certain asset protection features.
o) Universal Life Insurance
Universal life insurance will often combine a savings component with a (lifelong) death benefit to be paid out to the beneficiaries. The savings growth will in many jurisdictions have a tax-preferred treatment. Universal life contracts are regularly used for liquidity planning (for example to ensure payment of inheritance taxes without having to sell participations of a company or a real estate), for succession planning, for tax planning and for asset protection.
p) Local Investments with foreign Investment Exposure
A number of jurisdictions have generated tax planning opportunities when investing into local investments with foreign investment exposure, instead of doing so directly. This can for example consist of the jurisdiction permitting the issue of local certificates representing foreign investments, a second registration of the foreign investments in the domestic market, etc. Often those local investments can be booked offshore without the local tax resident losing the respective tax advantages.
q) Residency Planning
More and more high net-worth families are trying to escape economic, political, physical, legal and tax uncertainty as well as world-wide exchange of information systems transmitting financial information to their domestic tax authorities, by relocating family members or the complete family to a different jurisdiction. Exit taxes may be applicable, and families will be well advised to create substance at the new jurisdiction by effectively moving their center of vital interest and ensuring closer economic ties to the new jurisdiction.
r) Pension Funds
Participating in pension plans can be an interesting tax planning, asset protection and/or liquidity planning tool.
s) Family Protocol
For families controlling complex assets such as family businesses, family governance can set rules on how a family wants to treat the family business over generations and sets up rules and processes on how the family members interact between themselves. The overriding family governance tool is the family protocol (sometimes also called family charter). The main objective of the family protocol is that ownership of a family business transferred to the next generations by some of the tools outlined above will be kept and run within the family for future generations, thereby substantially increasing the probability of the enterprise surviving and staying within the family for the next generations. The family protocol is a dynamic, non-legally binding document based on joint consent of the family members. In order to ensure that certain parts of the family protocol become legally binding several of the tools above can be used, as well as the shareholder agreement.
t) Shareholder Agreements
For families owning a family business, shareholder agreements between the shareholders will provide a legally binding way to maintain control within the family.
3. Tax Planning
a) Income and/or Capital Gains Tax Planning
As outlined above, there are many tools which – depending on the applicable tax laws and the specific needs of the family – may be used for tax planning. For income tax planning, companies with the use of double tax treaties, usufruct, trusts, charitable foundations, private placement life insurance, universal life insurance, local investments with foreign investment content, relocation as well as pension funds may generate a positive tax impact if and when structured properly. Because tax law is complex and changes regularly it is important to obtain local tax advice in the respective jurisdiction(s).
b) Wealth Tax Planning
Not all jurisdictions have wealth taxes. Usufruct, use of companies benefiting of double tax treaties, trusts, charitable foundations, private placement life insurance, universal life insurance, local investments with foreign investment content, relocation as well as pension funds may all be used to partially or totally reduce wealth taxes depending on the involved jurisdiction(s).
c) Inheritance Tax Planning
Not all jurisdictions have inheritance taxes (philosophy of law would suggest that inheritance taxes should not be applicable when wealth taxes are in place and vice-versa). Depending on the jurisdiction, usufruct, trusts, private placement life insurance, universal life insurance, relocation as well as pension funds may be used to reduce inheritance tax exposure.
d) Other Taxes
When structuring a wealth plan it is important not to trigger unwanted tax events such as gift taxes and/or other transfer taxes. Careful consideration has to be given when using one of the above mentioned tools as to what (if any) the tax implications are for the involved parties and within the tool, upon entering into the tool, what they are during the lifetime of the tool, and once the tool is exited and/or terminated. Given that tax laws are complex and change frequently, it is stronglyadvised that local tax advice be obtained in the involved jurisdiction(s) when executing a wealth plan.
4. Succession Planning
Given that the worldwide legal framework caters for wealth to be transferred to legal heirs, it is not mandatory to proactively plan one’s succession. There are however many reasons suggesting that tailor-made planning has considerable advantages. It will enable the distribution of assets to be tailored in terms of amounts and time-lines (deferral of distributions or taking care of minor, incapacitated family members, for example by using a trust). It however may also be able to support the heirs by nominating an executor, guardian or trustee who assists heirs and beneficiaries to ensure smooth transfer of the assets, reducing costs and administrative complexity for example in the case of assets abroad. Planning of domestic assets will therefore often be implemented through a will and maybe a domestic trust or foundation. The generational transfer of foreign assets then again may often be planned by using offshore trusts, family foundations or life insurance contracts. Liquidity to pay inheritance tax without having to sell parts of the estate may be generated by using a universal life insurance policy.
If set up properly, the trusts may partially also reduce inheritance tax exposure. In certain countries life-time gifts, usufruct or re-purchase agreements may reduce inheritance tax exposure.
Individuals wanting to plan their succession will be well advised to do so in good time, in order to ensure that the plan stands in case of unforeseeable events like accidents, but also in case of incapacity which normally will also render future planning impossible. Succession plans will have to be reviewed regularly, in order to ensure that they still fit the changing needs of the family, but also to adjust them to legal and tax changes in the applicable jurisdictions of the family members and assets.
When transferring family businesses or participations thereof, it will almost always be essential not only to transfer ownership, but also to ensure management continuity. Tools to ensure this are for example living wills, a family protocol and shareholder agreements. Due to the additional complexity, planning for management continuity will require considerably more time than planning the succession of ownership. As a matter of best practice a business continuity plan for family businesses should always be in place and regularly be reviewed. It should be coordinated with the succession plan of ownership of the family business.
5. Asset Protection
In order to limit losses from claims of professional malpractice (for example medical staff, architects, lawyers), business disputes, injuries against owners of rented out real estate, when investing into foreign markets with potentially unpredictable political and legal systems, but also for divorce cases, it may be advisable to enter into certain asset protection schemes. Depending on the type of risk to be mitigated, adequate tools may be establishing domestic or foreign irrevocable trusts, spendthrift trusts for the next generation, life insurance contracts (both private placement life insurance as well as universal life insurance contracts), buy-sell agreements, and/or pension fund investments.
It is important to note that asset protection schemes will only work out if they are implemented before a specific problem arises. These schemes will usually not generate the desired impact if they deliberately intend to frustrate a specific, known creditor, as the transaction will almost certainly be challenged as a fraudulent transfer and, if successful, will be voided by a court. Depending on the case, in some countries even criminal liability may arise when not done well in advance and without wanting to prevent payment of a specific obligation.
Another issue to take into consideration is that whereas the structures of an irrevocable trust, and life insurance contracts will hardly be able to be attacked, the transfer into the scheme may be more vulnerable to legal contestation, for example by arguing the case of fraudulent conveyance (actio pauliana).
Another tool limiting liability can be the use of limited liability companies (LLCs), prenuptial and matrimonial agreements, but also asset protection treaties when investing into counties with higher political and legal risks.
A rather basic asset protection scheme can be to transfer assets to a family member with lower risk exposure. This however can backfire strongly when the family member turns out to be a poorer risk than the potential creditors. Careful consideration also has to be taken to avoid potential gift and other transfer taxes. In some jurisdictions joint holdings may provide some asset protection features (for example small homestead exemptions).
6. Conclusion
Establishing a comprehensive and holistic wealth plan for a family with assets and family members in different jurisdictions is a highly complex endeavor and will require a strong legal – if possible civil and common law – background with a strong international focus. Broad and longstanding international financial sector experience will likewise be indispensable, given the nature, sophistication, and complexity of many of the tools. Creating such a wealth plan requires cocoordinating a highly skilled, multi-disciplinary, international group of professionals such as domestic and international accountants, lawyers, tax lawyers, product providers, family officers and bankers.
Copyright by René M. La Barre, Global Wealth Management Consulting GmbH, www.gwmc.ch, September 2020. All rights reserved.
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