For high-net-worth individuals and families, the preservation and transfer of wealth is of paramount importance. Professional assistance with wealth management and financial planning is essential for ensuring that wealth can be kept safe and passed on to the next generation according to your wishes. Comprehensive financial planning, incorporating cash flow management, tax strategies, giving strategies and succession planning, is something that all high-net-worth families should include in their wealth preservation efforts. Here is our guide for creating a financial plan that effectively protects wealth, and makes the best provision for passing it on intact.
Understanding Cash Flow Management for Wealth Preservation
The plan to create, preserve and transfer your family’s wealth should consist of two parts. The first is a plan for wealth creation and preservation. The second is a financial plan that determines how your money should be spent and saved. In this guide, we focus on this second part – a thorough financial plan. When you and your advisors are busy creating a financial plan, one of the most important things you will need to focus on, and be sure to include in your planning, is cash flow management.
The core elements of cash flow management are:
- Cash flow forecasting
- Balancing income and expenditures
- Careful, real-time monitoring of both inflows and outflows of cash
- Monitoring and replenishing reserves
- Managing liabilities
Cash flow management is a day-to-day function that helps you keep your spending under control. It may seem like a short-term consideration, but daily cash flow management, provided it is practised in line with a consistent, far-reaching strategy, will ensure that more of your wealth remains intact and is available to be passed on to the next generation. A good cash flow strategy helps you sustain your wealth and make yourself and your family more tax-efficient. It also empowers you to keep money aside for unexpected expenses and to have sufficient liquidity available to take advantage of new investment opportunities.
Financial planners use a variety of tools for cash flow management, including equity compensation management, deferred compensation management, and cash balance plans, among others.
Optimizing Tax Strategies with Income Splitting
A central aspect of a financial plan for any high-net-worth family is tax planning. If you do not make the right provisions and take appropriate steps, you could lose large portions of your wealth to estate tax, capital gains tax and other taxes levied by federal and provincial authorities. There are many tactics you can use to optimize your taxes. One of the most popular and effective is income splitting.
Income splitting is commonly applied by tax planning professionals in Canada on behalf of their HNWI clients. Simply put, it is a tax reduction strategy that involves reducing a family’s overall tax liability. It works by adjusting income levels among family members so that some of them take on a higher individual tax burden, while that of other members, as well as the family as a whole, is significantly reduced. The family as a collective will pay lower taxes, although one or more members family members will experience a relative increase in their tax burden.
This method can be applied equitably by rotating the increased tax burden among family members from year to year. It is important to remember and be considerate of the federal Tax On Split Income (TOSI) rules when using this tactic. These were implemented to prevent the abuse or unreasonable use of income splitting and ensure that the tax system is as equitable as possible. Families and family-owned businesses can still take advantage of income splitting, but they need to do so carefully, using TOSI guidelines. These rules make income splitting a little more complicated, but it can still work.
Some of the methods that families use to take advantage of the TOSI regulations are:
- Pension splitting
- Loans to spouses
- Loans to a family trust
- Salaries paid to family members from a family-owned business
- Loans to adult children (especially to buy a home).
The Role of Trusts When Creating a Financial Plan
One of the most useful estate planning tools for high-net-worth families is a trust. A trust is a legal arrangement that allows a person or organization to pass assets into the management of a third party on behalf of designated beneficiaries. Family trusts can be used as a way of protecting and passing on assets. The owner of the assets – known as the settlor – places them in the trust so that their beneficiaries, such as their children and grandchildren, can enjoy the income they generate in line with the settlor’s plans and wishes. One or more trustees are appointed to manage the assets and given powers to dispose of them in accordance with the settlor’s wishes. The trustees could be parents, grandparents, or even someone outside of the family, such as an attorney or financial advisor.
There are two kinds of trusts – testamentary trusts and living (inter vivos) trusts
- Testamentary trusts: These only become effective once the settlor has died. The assets held in a testamentary trust will then form part of the settlor’s estate, and so they are subject to any applicable estate fees or taxes.
- Inter vivos trusts: These are trusts that are effective during the settlor’s lifetime. As the settlor, you can transfer assets into the trust for your beneficiaries, with the management of your chosen trustees. Once the transfer is complete, you are no longer the owner of those assets. You can add more assets to the trust whenever you choose. Perhaps most importantly, since the assets held by the trust are no longer technically yours, such a trust would not form part of your estate when you pass away, and would not be subject to probate fees or terminal taxes.
Philanthropy | Maximize Impact with a Giving Strategy
Philanthropy brings its own rewards, but there is no reason why you shouldn’t be smart with it, and leverage your charitable giving as a method of reducing your family’s tax liability. When creating a financial plan, find ways to include your charitable donations. Donations to your favourite causes can be strategized in such a way that they trigger tax credits.
Strategic giving provides a chance for you to bring your financial planning into alignment with your highest values. Before developing a giving strategy, take some time to research many charities. Choose the ones that are closely aligned with what matters most to you. What are the causes that mean the most to you? Needy children? The prevention of animal cruelty? Perhaps healthcare or the environment? Once you have chosen a cause that you would be proud to give your money to, select the most appropriate giving strategy. This could include donor-advised funds, charitable trusts, direct donations, or a combination of these approaches.
There are many ways to integrate your family’s charitable donations into your financial planning. It is always best to discuss the matter with a financial advisor to ensure you can use the strategy optimally. Charitable trusts and donor-advised funds are tools that are popularly used for this purpose. For more information, read our article on philanthropy here.
The Importance of Succession Planning for Family Businesses
Succession planning is an important consideration for any business, but it is particularly vital in the case of family-run companies. Succession planning helps to ensure the smooth transfer of leadership and information from outgoing leaders to new ones. It helps to reduce disruptions and risks, ensures that the organizational culture is upheld, and helps to retain crucial talent. A business needs to continue running, unimpeded and without disruptions, regardless of who holds the senior leadership positions, and this is what makes succession management so important.
There are several important points to keep in mind when strategizing the succession of both management and shareholders. Lawyers and financial advisors should be consulted every step of the way, and it is also crucial to create separate plans for shareholder and management succession. Once again, as with all other aspects of your financial planning, taxes form an important part of the decision-making process when it comes to succession planning.
Passive vs. Active Investing | Which is Right for You?
Naturally, investments form a central part of any high-net-worth family’s wealth-building and preservation strategies. There are many different ways to invest, however, and each investor needs to think carefully before choosing the investment method and strategy that best suits them.
A wealth manager or investment advisor should always be consulted to determine the best investment strategy and investment targets. Although the specifics of your approach and portfolio are something that you would need to work out with your wealth manager, we can make a general note here about the two broad categories of investment – active and passive.
Active investing is a direct, hands-on approach for investors who are prepared to seek out and buy new stocks, bonds, property etc. for themselves. Active investors monitor and correct their own portfolios – or hire a wealth manager to do so on their behalf.
A passive investment strategy usually involves putting one’s money into investment accounts, mutual funds or exchange-traded funds, which are usually managed by institutions such as investment banks. These investors rely on dedicated fund managers to monitor their investments and make adjustments when necessary. This method is less hands-on and generally less risky than active investing. There is not necessarily any right or wrong way to invest. You can choose to be either an active or passive investor and see great returns either way. The important thing is to make sure that the strategy you choose is aligned with your goals, resources, temperament, knowledge and appetite for risk.
Momentum Wealth of Aligned Capital Partners Inc. is a boutique wealth management firm and Momentum Financial Services Inc. is a financial planning firm based in Halton Hills, ON. Contact us to begin working with one of our experts, who can advise and assist you in creating a plan.
