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NEWS - PLANNING
Passing on wealth
8/30/2004
Many people devote their lives to the accumulation of wealth, but put little thought into how they pass it on to the next generation. But financial assistance for children - especially when they are still financially dependent - should be an integral part of what is described as estate planning.
An estate plan centres on such matters as having adequate life insurance so that there is enough money for dependants in the event of the death of one or both parents while they are raising a family. Under the plan, this insurance needs to be combined with a properly prepared and regularly updated last will and testament that expresses your wishes on how this and any other assets you own will be distributed.
But providing financial help for the next generation need not just be related to death. Parents can also help by giving adult children financial help to start a business, to buy a home or to help educate their children (your grandchildren).
"It's increasingly common," says lawyer Chris Ketsakidis, a partner with Melbourne firm Hall & Wilcox, "for grandparents to make financial arrangements to help in the education of their grandchildren, initially while the grandparents are still living and later when they are not."
Through the medium of a testamentary trust, his own late father is helping to pay for his grandchildren's education. Special features of testamentary trusts mean they can be very tax effective.
Giving the children of future generations the best possible education is a far-sighted way of distributing family wealth to the next generation, says Don Stammer, the former economist and investment adviser who now spends his semi-retirement giving public lectures to financial advisers and their clients on wealth accumulation. He is also chairman of the listed ING Property Trust. Transferring money is only part of the issue, he says: making sure the next generation is properly prepared for that wealth is just as important.
"While many people think that having a million dollars in life insurance or superannuation will ensure their dependants will be properly looked after should they die, that is only part of the equation," says Peter Bobbin, a lawyer with Sydney solicitors the Argyle partnership, who specialises in personal finance and superannuation.
That's because putting a large sum of money in the hands of a young person who isn't ready to look after it can be a recipe for disaster. With the trend towards older parents, it is increasingly likely that a family inheritance will go to younger children who are highly likely to waste it if they haven't been financially educated.
Bobbin says this happens because when young people come into money, they may find they have a lot of friends eager to help them spend it. "In no time a large chunk of an inheritance is dissipated in a combination of lavish lifestyle and failed business ventures," he says.
Young people who are financially immature are also the most vulnerable to scams and schemes promoted by unscrupulous people of which there are, unfortunately, many in the financial services area. This is one area that will be addressed by Merrill Lynch in a series of seminars its private client team is preparing for young people who stand to inherit.
What the scammers rely on and prey on is that the young person will have no appreciation of how hard it was to create the wealth that has come their way. This is consistent with the commonly accepted theory of generational wealth dispersion: that the first generation makes the money, the second generation maintains or adds to it and the third spends (or wastes) it. The first generation works so hard they have no time to enjoy the fruits of their labour; the second have seen how hard their parents worked and appreciate what was involved in creating the wealth. "For the third generation however, the wealth was just there and is seen as a right and not a privilege," Bobbin says.
Lawyer Daniel Butler, a superannuation and estate planning specialist with DBA Butler of Melbourne, says some families do get it right. "You see this where families have a properly structured succession plan for a family business that will be handed on to the next generation," he says. "You see it where people bring their children along to meetings with financial planners and other advisers so they can become familiar with the way the world of finance works."
A good example is not just to give adult children the money to start a business or to buy a home, but rather to lend it to them. This circumvents a couple of possible developments. One is that the money will to a certain extent be protected if there is a marriage break-up or a business failure.
"Divorce risks are high these days," Butler says. "If you give your child the money to buy their own home, half can be lost in any divorce settlement." If it's a loan, however - properly documented - it stays a family asset. Only the net value of assets is split on divorce.
Where a formal loan is made to help start a business, if the business then folds and there are some assets remaining, the parent will then be a creditor along with anyone else who is owed money.
Loans to children are often interest-only or no-interest arrangements but with an agreement that the money can be called upon at any time.
10 TIPS TO MAKE THE NEXT GENERATION FINANCIALLY SAVVY AND SECURE
1. Encourage the savings habit as early as possible by suggesting young children put 10¢ to 15¢ of every dollar they earn or receive into a savings account. This will highlight two important issues: what is involved in accumulating money and the value of compounding.
2. Encourage interest in growth investments such as shares and highlight the compounding effect of reinvesting dividends and the tax features of dividend imputation. To explain compounding: when money is invested, it produces earnings that can then be reinvested, so you receive earnings on your earnings in addition to the earnings on your original investment. This added boost is the power of compounding, and the longer the money is invested, the more powerful its effects. Over long periods of time - 10, 20 or 30 years - the effects of compounding at different rates can be substantial. For instance, if you invested $20,000 today and it earned an average annual 8 per cent after tax, you would have $43,200 at the end of 10 years and $93,200 after 20 years. If it earned 9 per cent you would have more than $112,100 after 20 years. That's nearly $19,000 more as a result of a 1 per cent difference in annual return.
3. Follow the government's lead on super co-contributions by offering to match your children's savings on a dollar-for-dollar basis where they have a savings goal. Do the same when children want to make a major purchase, such as their first car.
4. If you want to give adult children some help to go into business or buy a house, rather than give them money, lend it to them on either an interest-only or interest-free arrangement with the intention of forgiving the loan at a future date. This discourages an easy-come, easy-go attitude in the next generation. Loans also provide some protection in the event of a divorce or business failure. Make sure there is a formal loan agreement signed by the parties involved. Otherwise it could be argued it was a gift and be included in any divorce settlement.
5. Build a testamentary trust into your will for all the reasons mentioned in this report.
6. Make sure you have adequate life insurance. Be aware that most of us are under-insured.
7. Encourage your adult children to have adequate life insurance, especially when they become parents. If they can't afford it, consider helping them financially by paying for this insurance. A benefit of this is that should tragedy strike, it is very possible you might be called upon to help bring up your grandchildren.
8. Once they are old enough to understand, include the next generation in any major discussions about family finances so they can gain a greater appreciation of what is involved. This should extend to discussions where professional advisers are involved.
9. Have an estate plan where the next generation is encouraged to co-manage any inheritance or trust funds with either a parent or a mentor if they are still financially immature. Avoid situations where the next generation is thrown in at the deep end. This is not a good way to learn about personal finance.
10. Make sure you are financially literate before offering any advice to the next generation.
Reproduced from the Australian Financial Review - 30 Aug 2004
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