There are principally three ways that family wealth erodes over time:
Spending, Inflation & Taxes
Here's what you can do about them.
We work with families to help them understand how much they can withdraw from their investment portfolios on a regular basis whilst still ensuring that future generations can benefit from the family’s accumulated wealth.
But, of course, preserving wealth isn’t always the first priority for people and in many instances it is largely ongoing spending that erodes wealth. Beyond some education, there’s not much we can do about that!
The other two factors are a little less obvious but can seriously erode even passively managed wealth (i.e. wealth that is not ‘spent’ but is simply left to, in theory, grow over time).
Inflation is the silent killer of wealth. Keeping pace with it is therefore a good baseline goal for any long term oriented investment portfolio. In fact, we expect that a long term portfolio would do better than inflation largely by investing in shares of companies, which is a strategy that contains some inherent inflation-protecting attributes.
For example, the price of a Kit Kat today is about 100 times the price of the Kit Kat 50 years ago. As a shareholder of the company that sells the Kit Kat you benefit from these price increases in a way that you would not if, for example, you simply kept your money in a savings account.
The trade off is that the share price of the Kit Kat company will inevitably fluctuate and sometimes in a quite extreme way. To at least some extent, a wealthy family needs to accept these fluctuations as the price for owning investments with embedded inflation-protecting characteristics. Determining the proportion of these investments within the portfolio is an output of the financial planning process.
Nothing is certain in life except death and taxes. And, in fact, with death comes even more tax! But there is plenty that can be done to minimise tax and the cumulative effect of doing so for a wealthy family with a multigenerational time frame can be absolutely huge.
Simple solutions like ISAs, Lifetime ISAs and Junior ISAs can, over time, add up to a meaningful tax shelter even for families with a net worth in the tens of millions. For example, grandparents with three married children and nine grandchildren could contribute almost £250,000 per year to these very basic structures.
Pensions are a bit more complicated but offer further planning opportunities especially now that the annual allowance limit has increased to £60,000 and the ‘lifetime allowance’ has been scrapped. Any person can contribute to any other person’s pension, so wealthy families really should consider topping up the pensions of younger generations if they want to tax efficiently pass on their wealth (there’s perhaps an additional benefit in that the beneficiary cannot access the funds until they are in their fifties and, perhaps, past the point of ‘youthful indiscretions’...).
Somewhat more complicated but still pretty bog standard in the world of financial planning are trusts intended to mitigate inheritance tax. It's usually most tax efficient to contribute £325,000 per person (so, £650,000 per couple) every seven years. That adds up to a fair bit of wealth over time.
There are also certain investments that offer both tax breaks upfront, potentially very attractive long term returns and are free of inheritance tax (e.g. EIS funds).
The Bottom Line
The bottom line with regards tax planning for wealthy families is that it’s far easier to be tax efficient with a large sum of money if the planning is implemented each and every year. Having one big sum of money to give away late in life, or on death, will almost always lead to a much higher tax bill.
The bottom line with regards to investing is to earn at least as much as inflation and ideally a bit more.
Then the ‘silent killer’ of wealth becomes, in fact, a tailwind.
Spending is perhaps too individually oriented to have a firm ‘bottom line’ but if your priority is to pass on the family’s wealth then selling as little of the family silverware as possible is the only answer.