When people come into family money quickly, often due to the sale of a business or liquidity event, there is a significant learning curve understanding the responsibility that comes with newfound wealth. How will people perceive you? How will your day-to-day life change?
Following his last article on Planning for Family Offices, Mayeer Pearl, Audit & Advisory Partner and SuRE (Succession, Retirement and Estate Planning) Group member, continues the discussion on the responsibilities wealthy families have to successfully preserve, manage and maintain their net worth for future generations.
Education is key.
The first and most crucial step is to educate yourself, and especially your children, on the importance of investments, capital preservation, and philanthropic responsibilities. Remind your family that money doesn’t make you better than anyone else – it just makes you luckier.
You’re doing no service to your 16-year-old child by buying them a brand-new Ferrari. (If anything, you’re doing them a disservice.) Now, that’s not to say the wealth doesn’t afford you a certain lifestyle, however, you need to temper it with what’s appropriate for your family situation. Nobody wants their child being known as that spoiled brat who shows up to school in a luxury car, however, there’s no reason for them not to have a car, just one that is appropriate for a young adult.
Educate your children to understand that an inheritance is not their right. It’s nice if parents leave money for their children, but there’s no obligation to do so. Children also must learn that just because their parents are rich, doesn’t mean they don’t have to work. As an advisor, I work with far too many people who look at their family’s wealth not as their potential future inheritance but as their right today even though their parents are still alive. These children worry that every time the parents spend money, they’re spending part of their inheritance. False. The parents are spending their own money that might become the child’s, one day.
Finding a financial advisor is only one piece of the puzzle.It’s true that some people who come into wealth can figure out themselves how to manage it and may not need professional assistance. However, many others may need help simply grasping the scope of work that needs to be done and instilling in their children that while they have a privilege, it doesn’t negate their responsibilities to make a living on their own.
The ones who made the money usually feels like they have a responsibility to maintain this capital and preserve it for the next generation. They have worked hard to create this wealth and continue to work hard to maintain it and not put it at risk. Without the proper discipline to adjust their lifestyle to their newfound wealth, it’s dangerously easy to squander. Advisors are necessary, in certain cases, because even though the family has created a life-changing amount of capital, it may not provide a life-changing amount of income to sustain the family and its new lifestyle wants.
Many small business owners may have a successful enterprise that brings them upwards of $800,000 a year in income and they live quite well on this level of income. They have a strong, stable business that will continue to earn this income year over year and then someone comes along and offers them $15 million for their business. In their mind, the sale of their business for such a vast sum of money seems to will change their lives overnight and now they have a massive surplus of capital. Most assume they’ll also experience a massive improvement in lifestyle but quite honestly, if you take that $15 million and invest it at today’s rates and you’re conservative with your money, you’ll earn five per cent of that or approximately $750,000 per year which is less than they would be currently earning.
While they no longer have the stress and commitment of running their business, they are now earning slightly less than what they were making before the sale. The sale of their business does not allow them to drastically change their lifestyle and comfortability of living. It doesn’t give them the freedom to start “living it up” any more than they were before. Yes, more capital and security frees up time and eliminates many stresses but people need to understand that they can’t look at these large amounts of capital – they need to look at the income generated from the invested capital. They have to look at it strategically and ask themselves, “What is my income now and how do I live using that income?” as opposed to, “Wow, I’m rich! I can live like a king!” Perhaps they are going to have increased income, but they must first understand the implications before they dive zero-to-one hundred into a higher lifestyle.
Understand the many ways to give back and make an impact.
Considering discrepancies between class structures in today’s day and age, with liquidity events (like the sale of a business) comes a moral obligation to give back to the community. While a lot of families want to, they don’t necessarily know how to put together a strategic philanthropic plan.
There are a lot of great resources and public foundations out there that will work with families to help them figure out what their funding priorities are, how to fund them in the most tax-effective manner, and how to really make an impact in the lives of others. Some example of these resources include The Association of Fundraising Professionals, The Toronto Foundation, The Philanthropic Foundation Canada, The Jewish Foundation of Greater Toronto.
There is a tremendous amount of impact that families can make, but it must be done with the right advice on how to go about giving and how to then ensure the charities become accountable to the donor on how they spend the money. It’s crucial to measure your impact and make sure that the money is being utilized as you were told it was going to be.
There are consultants available to help wealthy families understand the way charities work. When people make a $20-$500 charitable donation, they generally don’t have a say in where that money is allocated. But when you start making meaningful donations in increment of hundreds of thousands of dollars (or even millions), there needs to be accountability back to the family on how their donation is being used. It is important to have a donor agreement between the family and the charity spelling out requirements and obligations of both the charity and donor. Yes, both the donor and the charity have an obligation. A family shouldn’t write a cheque to an organization for $1 million and just say, “Go to town!” A donor needs to know what it is being used for and is entitled to accountability. Without transparency, that charity could use your donation to fund a severance package for a staff member they want to terminate. And while that may, for whatever reason, be the best use of that money, either way – as the donor, you deserve to know how your donation is being spent.
It is also important to understand the most effect method to give. There are certain ways that are tax advantageous, such as donating shares of a public company with an accrued gain in them, as gifting those shares is far more effective than gifting cash. Work with your advisors to understand how you can make the biggest impact. You may say, “Well, I’m happy to give $100,000,” but understand that donating $100,000 of cash versus donating shares with a cost of $100,000 that are now worth $250,000, you can make a much bigger impact giving away the shares than you can with the cash. Strategizing with your advisors to figure out the best way to give is key and is a significant responsibility of wealthy families.
Many business owners have life insurance in place to help manage their tax liability on death. If they have a liquidity event during their lifetime, they may no longer need the insurance to help manage the tax on death. These policies that are no longer needed to fund tax are great vehicles to help achieve philanthropic goals. By using life insurance to donate to charity the donor doesn’t tie up any of their assets today and can set it up to make a significant gift while using very little money to generate that gift.
Remember that it’s not just money that can be donated. A lot of times after a liquidity event, you have more time on your hands and there’s the ability to give back not just with dollars and cents, but with your time. Charities need a lot of help from volunteers across a wide range of activities and many of these former business owners have a lot of unique expertise that they can offer. There’s an opportunity to give back with not just your money but your time, experience, and assistance in networking to meet other potential donors and supporters.
Get yourself organized.The final piece in understanding the responsibility of wealth is responsibility to be organized yourself. Make sure your wills are up to date. Make sure you’ve got estate planning up to date. Both of your wills and estate plans come together to reflect the goals you have in mind and what you want accomplished. For example, if you own a business prior to a liquidity event, you may want everything to be passed on your children. After a liquidity event, you now have a responsibility to look at your wills and ask yourself, “Is this still what I want?” Now that you’ve got the surplus of capital, do you want some of it to go to philanthropic goals upon your death? Do you have other people that you want to help because you have the cash to do it?
Everyone should be re-examining their wills every five to seven years, at minimum. Life changes. Your kids get older. You get older. And certain things may come to light that impact your wishes and decisions. Perhaps your children have gained maturity, grown up, and now you feel comfortable having them as your executors. It is your responsibility to be consistently revising your wills and estate plans to meet your current goals – not what your goals were 10-20 years ago when you first wrote the will. Until the day you die, your will is a living and evolving document. Yes, people don’t like thinking about and facing the thought of death, but it’s a difficult and important conversation to be had. Whether or not you involve your children at all in your will and estate planning is, frankly, a personal choice. But whatever you decide to do doesn’t necessarily impact only your children, you need to consider if what you’re doing makes sense for everybody involved.
Specific professional advice should be obtained prior to the implementation of any suggestion contained in this article. Contact your Crowe Soberman advisor for more information.