Many investors face the challenge that their investment budget is too small for a family office and too large for standard retail client solutions. For these investors, finding a family office wealth management style for their investment portfolios is essential.
Last year UK entrepreneurs made £11.8bn selling their businesses, and this was despite economic challenges, compared to previous years where it was more than 60% higher, netting £29.1bn. Once a typical entrepreneur has built a successful business, he may sell part or all of the company to focus on other opportunities, and the proceeds are in the bank—as then do they manage their wealth?
Often, the case is treated as a family case, with two parents usually in their 50s or early 60s and the children perhaps in their 20s. The two most common objectives for them are to protect capital by ensuring multi-generational inheritance and for the entrepreneur to retain control over how this objective is achieved.
The seven-year gift as a last resort?
Despite these clear objectives, many families feel that donating a lump sum at this stage – when they think they will live the seven years required for the financial gift to be inheritance tax-free – is the smartest option.
However, this can be fraught with potential drawbacks; from the risk of inflation to losing control over the amount of the ‘gift’ when a child marries or divorces, to sibling squabbles when an older child invests in property and reaps asset appreciation but a younger sibling feels disadvantaged when property prices have moved forward. the amount of the gift.
In fact, giving away a large sum may not even achieve the primary objective of maintaining control or creating inherited wealth. Sometimes, this may mean that the entrepreneur has reduced the amount of capital through gifts to such an extent that, accounting for the rest of their life, they do not have enough money left to live as they wish.
Family Investment Companies (FIC)
There are alternatives for those with, say, £2m or more to invest: Family Investment Companies (FICs). These are a company wrapper with which entrepreneurs are familiar and comfortable, they provide a flexible and tax-efficient vehicle where different classes of shares can be allocated to different beneficiaries, and control is held by one class of shares (which held by the entrepreneur). Simply put, it sets the ground rules for a common understanding of how the estate will be managed.
Within a FIC structure, corporation tax is paid on its income and capital gains, however:
- Dividends received by the company are tax free in most cases.
- Through careful structuring, there is the possibility that an increase in asset values may be outside of individuals’ assets for IHT purposes.
- Funds can be released from the FIC through dividend and salary payments to shareholders to utilize their available personal allowances and basic rate bands.
- FIC loans are a good way of releasing capital to shareholders without claiming the seven-year IHT rule. Investment management fees – paid based on a percentage of assets – are tax deductible for FICs, which are not for individuals.
FICs have become increasingly popular since regulations in 2006 made trusts less attractive. HMRC, having stress tested FICs and confirmed they were not used for widespread tax avoidance, effectively giving these structures the all-clear to mitigate IHT through multi-generational estate planning.
In terms of multi-generational wealth, it is notable that trusts have a ‘lifespan’ of 125 years, while the FIC structure can last in perpetuity. Indeed, we have encountered FICs that have been multigenerational since the early 1900s.
Capital preservation overcomes risk appetite
While entrepreneurs are known for having a higher risk appetite, in our experience once the business is sold, this appetite is satiated; the focus shifts to capital preservation and income generation. Entrepreneurs tend to keep higher risk private equity investments separate. All FICs we manage are invested in a diverse set of asset classes and geographies in line with client objectives.
Money can be a good opportunity, but if handled carelessly, it can have a detrimental effect on relationships. We advocate for the reunification of the entire family – or primary beneficiaries – before a FIC is formalized. The process can be a valuable tool for training new generations of gainers in the psychology of wealth.
As the first generation of beneficiaries matures, multiple FICs can be created for different family households. This allows each family to reflect their own investment values, risk appetite and we manage their portfolios accordingly, all within an investment structure built by tax experts that they are familiar with.
Edd Hollier is a senior director and investment manager at EFG Harris Allday and Phil Pellegrini is tax partner, private clients at Dains Accountants