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 style of wealth management for their investment portfolios is essential.
Last year UK entrepreneurs made £11.8bn by selling their businesses, and that was despite economic challenges, compared with previous years where it’s been more than 60% higher, releasing £29.1bn. Once a typical entrepreneur has built a successful business, they may sell part or all of the company to focus on other opportunities and this realised cash is in the bank – how then do they manage their wealth?
Often, the issue is approached as a family household, with two parents usually in their 50s or early 60s and children perhaps in their 20s. The two most common objectives for them are to protect capital while ensuring multi-generational legacy, and for the entrepreneur to retain control over how that objective is achieved.
Seven-year gift as a last resort?
Despite these clear objectives, many families are under the impression that gifting a sum at this stage – when they feel likely to live out the requisite seven years for the financial gift to be Inheritance Tax-free – is the smartest option.
This could be riddled with potential drawbacks though; from inflation risk to loss of control over the ‘gift’ sum 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 ahead of their ‘gift’ sum.
In fact, gifting a lump sum may not achieve either key objective of retaining control or creating legacy wealth. Sometimes, it can mean the entrepreneur has diminished the capital sum through gifting to an extent that, calculating for the rest of their life, they don’t have enough money left to live as they wish.
Family Investment Companies (FICs)
There are alternatives for those with, say, £2m or above to invest: Family Investment Companies (FICs). These are a company wrapper, which entrepreneurs are familiar and comfortable with, they provide a flexible and tax-efficient vehicle whereby different share classes can be allocated to different beneficiaries, and control retained by one share class (held by the entrepreneur). Put simply, it sets the ground rules for a shared understanding of how the wealth will be managed.
Within an FIC structure, corporation tax is payable on its income and capital gains, however:
- Dividends received by the company are tax-free in most cases.
- Through careful structuring, there is the potential that an increase in asset values can be outside the individuals’ estates for IHT purposes.
- Funds can be released from the FIC through dividend and salary payments to shareholders to make use of their available personal allowances and basic rate bands.
- FIC loans are a good way of freeing capital to shareholders without requiring the seven-year IHT rule. investment management fees – paid based on a percentage of assets basis – are tax-deductible for FICs, which they are not for individuals.
FICs have become increasingly popular since 2006 regulations made trusts less attractive. HMRC, having stress tested FICs, and confirmed they have not been used for widespread tax avoidance, effectively giving these structures the all-clear for mitigation of IHT through multi-generational wealth planning.
In terms of multi-generational wealth, it’s notable that trusts have a ‘lifespan’ of 125 years whereas the FIC structure can last in perpetuity. Indeed, we have come across FICs that have been multigenerational since the early 1900’s.
Capital preservation beats risk appetite
While entrepreneurs are renowned for a higher risk appetite, in our experience once the business is sold this appetite is satiated; the focus switches to capital preservation and income-generation. Entrepreneurs tend to keep higher-risk private equity investments separate. All FICs we manage are invested in a diversified array of asset classes and geographies in line with the clients’ objectives.
Money can be a great enabler, but, if carelessly handled, can have a detrimental effect on relationships. We advocate bringing the whole family – or main beneficiaries – together prior to formalising an FIC. The process can be a valuable tool for preparing younger generations of beneficiaries in the psychology of wealth.
As the first generation of beneficiaries matures, multiple FICs can be created for different family households. This allows for each household to reflect their own investment values, risk appetite and for us to manage their portfolios in line with this, all within an investment structure constructed by tax experts, that they are familiar with.
Edd Hollier is senior director & investment manager at EFG Harris Allday and Phil Pellegrini is taxation partner, private clients at Dains Accountants
