Passing wealth on to future generations is complicated. How do you divide wealth among family members? What if they spend it in ways that you think reckless, stopping the flow to further generations?
If you want to stay wealthy for a lifetime and pass down wealth for future generations, you need a plan. Wealth managers have many approaches that they will customise for your specific situation and your wishes. But they almost all have similar themes that we can learn from.
The following steps can help to stay rich forever. Future generations will thank you.
Step 1: Stay rich enough to pass on wealth
A family fortune is no fortune at all if it’s riddled with debts, so pay them off. You can do this more easily by spending less and using the savings to pay down your balance. Usually, debt should not exceed more than 20% of your total net worth.
To preserve the wealth you have amassed, try your best to spend only from your passive income, such as from a rental property, interest income, or dividends from investable assets. If you need to exceed this, try not to spend more than 5% of your total net worth in any given year, advises the WSJ wealth reporter Robert Frank.
If you need help evaluating your expenses and any income streams you are receiving, Money Dashboard can help. The tools make it easy to visualise your money, your income and where you are spending. This helps make budgeting and succession planning more fact-based than guess work.
Step 2: Make sure your money is conservatively invested
Make sure you diversify. Although concentration of investments in a single business or sector is often how people amass wealth quickly, it’s also a fast way to lose it if market trends shift. We live in unusual and confusing times, and it would be folly to assume some assets will always retain or grow in value.
So take a bit of advice from the financial experts and diversify your assets. Stocks, bonds, alternative assets, real estate, cash, commodities and more might be worth spreading into. Robert Frank says no single asset should be worth more than 20% of your net worth. The result is lower risk exposure to world events.
Finally, aim for liquidity (for example, stocks are liquid because they are easier and faster to convert into cash than real estate, which takes more time and process to sell). Robert Frank says ideally 80% of your net worth is in liquid assets like stocks bonds and cash.
Step 3: How to stay rich for three generations
“How many generations does wealth last?” you ask. Good question.
You may know the saying “shirtsleeves to shirtsleeves in three generations”. It is a proverbial saying that means any wealth gained in one generation is sure to dry up by the third.
Statistically, the third generation rule is sound. The drop in inheritable wealth is pretty steep generation-to-generation, nearly flat lining on the fourth. But don’t lose heart, three generations is not bad, really, and if you plan right you could be an exception to the rule.
The first step for passing on wealth for three generations (or more) is to organise some estate planning services, advises to Anthony Fittizzi, a wealth strategist in the US.
Trusts in the UK are particularly valuable as they can shied assets from taxes, and just as valuably, from internal squabbling and ill-use from family members. Trusts ensure that as the original wealth creator, your values and wishes are carried out for all beneficiary generations.
Optimise your taxes
Secondly, optimise your taxes. UK inheritance taxes can be particularly painful if advanced measures aren’t taken to sidestep them. For example, money gifted at least seven years before death is currently not liable for inheritance tax. You can get help organising tax planning from a wealth manager, a solicitor or any money manager or helping you organise a family trust.
Finally, have an education plan for your beneficiaries and incentivise them well. A child growing up knowing they are set to inherit the key to millions with no strings attached at age 18 is probably a recipe for disaster (if you imagine a few years of partying on a luxury island as a disaster).
So set conditions for inheritance: must graduate from university, must hold a steady job for at least 5 years, must pass financial management courses, demonstrate sound investing and budgeting knowledge, and so on.
If it all goes to plan, your family fortune could live on.