Should you give your children an early inheritance?

BOITUMELO NTSOKO: Welcome to the Money Savvy podcast. I’m. Boitumelo Ntsoko. Many parents often wonder what’s the best way to pass on wealth to the next generation. Very often they consider this as part of their estate planning. But could giving your children an early inheritance be an option, and what are the benefits of doing so for parents and the children?

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To discuss this further I’m joined by Marius Fenwick, who is a certified financial planner at Wealthup. Welcome, Marius.

MARIUS FENWICK: Thank you Tumi, thank you for having me.

BOITUMELO NTSOKO: Is it better to give your children an inheritance while you are alive?

MARIUS FENWICK: Tumi, I think all of us as parents want to help our children and, if we’re in a position to do so, absolutely. But I think one needs to take a few things into consideration. I think it’s very noble to help children, but one’s got to think about going forward and the future, and I often tell my clients ‘Be mindful what you give away’. First think about your income in retirement; that can work against you and to your detriment.

I think there are a few things that one’s got to look at. One’s got to look at the family dynamics if it’s it a multi-generation kind of family, and the relationships between those children, because if you give to the one you should technically give to the others as well, and that eventually starts having a snowball effect on your financial planning.

re] the candidate’s parents still alive. If you think of, in today’s environment, a lot of people close to or even in retirement are still supporting their parents, and that’s quite a costly affair. If you look at something like high-care facilities, that can be north of R25 000 a month. So there are a lot of things one has to consider before one starts giving away the funds that are actually earmarked for your income the day that you retire.

BOITUMELO NTSOKO: Just staying on that, what are other factors that you need to consider before embarking on this?

MARIUS FENWICK: I think one’s got to bear in mind as well that the taxman always wants his due. He doesn’t necessarily have to wait until you die to get his estate duty. So as soon as you start donating or giving away, that’s subject to a donation tax of 20%. Sure, there’s a R100 000 abatement a year that you can get as a write-off. That could accumulate to R200 000 between spouses, but the 20% donation tax – one’s got to be mindful of it.

And then if you do give away, always do the calculation. We normally work, we try and draw less than 4% on investment value as an income. So if you do give or if you’re planning to donate some of your wealth, just go and do the calculations right.

If I’ve given away X, Y, Z, do I have sufficient capital? If I draw less than 4%, that will still provide you with a sustainable income. If that’s the case and you think the monetary side is fine, you should have sufficient wealth to give away. But you’ve just got to be mindful that the future unknown expenses – I mentioned the thing about frail-care medical costs going up as you get older – capital expenses, like replacing vehicles, your lifestyle choice, like moving to a retirement village, having overseas holidays and so on.

As soon as you start giving money away and you don’t have a source of regular income, you’ve got to rely on your investments. All those become a factor if you start reducing your capital pool.

BOITUMELO NTSOKO: Some parents struggle with whether to give their beneficiaries equal shares of the inheritance, or to give more to beneficiaries with greater needs. Regardless of when the beneficiaries get the inheritance, how should a parent navigate the scenario?

MARIUS FENWICK: It’s a tough one. You know, we see in our daily lives that money is a divider of families. We find so often that different children perceive different values for different assets. So the one thing is, if you don’t treat all equally and all fairly, it can cause a lot of ructions. I think at the onset, whatever one decides to do and to give to whoever, this should be discussed with the children and with the larger family so that there’s no surprises, you know, when the will gets read one day.

But I think what one should bear in mind is that inheritance is multi-generational. In other words, what I mean by that is that I might have two children or three children. Let’s say I’ve got two children and my one child might have one child and my other child might have three children. So there are four grandchildren. So the inheritance that goes to my two children will at some point feed down to the grandchildren. So if those families or those two children get exactly the same amount, unless you mentioned the grandchildren in your will as well, which is probably the way we suggest you do, they take a percentage, say for instance – just arbitrary figures – 70% goes to my children, 30% to my grandchildren, divided equally.

But if you say my two children are going to inherit at 25% each, my spouse should get 50%, eventually when they pass on, when they set up their wills, the one grandchild is going to have substantial benefit compared to the three grandchildren. So when it comes to the planning, as we say, we always look at a multi-generational kind of planning.

And then how do you treat children with different sizes – then special needs children probably justify getting a larger portion of the pie. If you’ve got a child who is either disabled or has a learning disability, or just can’t earn an income, and it comes back to the family dynamics – we haven’t had a situation where the larger family will say: ‘You know what, we don’t mind standing back and getting a smaller inheritance or not inheriting at all, but let poor Peter, Sue or whatever it might be, let them get the bulk of the assets, or can least let it go and sit in the trust until his passing, and then we are quite happy to inherit.’

So it all comes back to discussion and comes back to the family dynamics. I think that’s incredibly important.

What we’ve seen as well is that wealth differentials can play a huge role when it comes to advocating inheritance.

So if we look at a, let’s say, a second term passing – and let’s make an example of a, let’s say a farmer, let’s say that the dad passed away and there was a son and two daughters. The son inherited the farm – I’m talking about 10, 15 years ago – and each daughter inherited let’s say R1.5 million. Over time, and let’s say mom lives for another 15 years, in that time, that farm might’ve grown to value of R25 or R30 million. Yet the R1.5 million that they inherited most probably grew to R5 or R6 million. So the differential is huge.

So now the question must be asked if a mom passes away, should that be equalised and maybe benefit the two daughters, or is anyone going to inherit again on an equal basis? Again, that’s an issue that’s got to be discussed with I think all the people who are going to inherit.

There are a lot of intricacies when it comes to the estate-planning side and how to draft a will, and to who should get what.

BOITUMELO NTSOKO: Now, if someone chooses to give beneficiaries their inheritance early, is it better to distribute this inheritance in small portions over time?

MARIUS FENWICK: I think it depends on what the inheritance is for, or the donation – talking about a donation, it’s not an inheritance at that point. Is it for cash flow, is it to buy a house, is to start a business?

If it’s for buying a house or starting a business, obviously one would look at a lump sum distribution or a loan or a gift for whatever you want to do.

If it’s a monthly cash flow just to get them on their feet, then obviously the smaller amounts will apply.

But once again, one’s got to just be mindful as to the amount that you’re giving away, the affordability, and what your own income is going to be at retirement. Once again, there’s got to be fairness between the children. If you give to the one and don’t to the others, as I said, money is a big divider in families.

So whatever one does, it’s got to be, I think, accepted by everybody and fair to everybody. Instead of giving them money, it’s probably a better idea to set up the loan agreement and say, listen, I’m not going to give you R3 million. We can draw up a loan agreement. I’m going to lend you the R3 million, but in the will you can then put in that that R3 million doesn’t have to be called up. That’s part of the inheritance.

That’s one way you can actually overcome the donations tax because there’s a loan, and that loan will be seen as an asset in the estate.

You can just deal with that loan, as I say, as a bequeathment to the child that you lent that money to.

BOITUMELO NTSOKO: Now, what are some of the best ways to pass on an inheritance? Let’s say, for instance, a house or maybe share portfolios?

MARIUS FENWICK: It depends on the different assets. Cash is always the easiest thing to distribute. We find property causes a lot of problems. If you’ve got three children and let’s say there’s one property and, say, my three children are going to inherit the property, there is always the case that the one wants to sell, the other one wants to live there and the other one wants to rent it out. If all three have the same mindset, saying, right, we’re just going to sell the property and divide it, that’s fine. But we often find that there’s a conflict. First of all, each child has a different feeling about that property. Some are more emotionally attached to it, and some attach a bigger monetary value to it than others. So I’ll take more [care]. Unless there’s a real good reason, rather stipulate that the property should be sold and the proceeds should be distributed.

If there’s a second property and even like a family holiday home – you know, different children see things in different ways. The one child might say, I live overseas, I’m never going to see it, pay me out. I don’t want to own a part of the of that property. So if there’s one child that really is keen on the property, in some way that child’s got the option to buy the other two out with the other part of the inheritance they’ll receive.

Cash is quite easy. Family heirlooms and sentimental items are also a bit of a tough one. It depends who has more emotional attachment to family heirlooms and stuff that have passed on down the family. It all depends on the assets. Cash obviously is the easiest thing to do.

You mentioned shares. If the children or the people who receive the shares or the investment are familiar with it and it falls within their risk profile, by all means transfer the shares as is. If they are not, and they are not keen on pursuing it, rather sell them in the estate and do a cash distribution, and they can set up the investments like they want to.

BOITUMELO NTSOKO: How would a trust come into the situation?

MARIUS FENWICK: A trust works. I think a trust works very, very well if you’ve got a special-needs child or someone whom you’ve got to leave money to [who is] not very disciplined with money, and obviously minor children. Then a trust works very, very well.

A trust also works well if you transfer assets before they’ve actually gone through a substantial growth phase. So if you start up a business in the name of the trust, if you buy a property, maybe buy it in a trust provided it’s not your primary residence because capital gains tax, there’s no abatement in trusts and obviously the inclusion rate is much, much higher in trusts than in individual’s names.

So one can, during your lifetime, between spouses, donate R200 000, either to children or to a trust that will reduce your estate value to start off one. And it’s a way to build value inside the trust. And of course it you pass away and you’ve got a R3.5 million abatement, you can transfer that into the trust. If both parties pass away over a certain period, that can push it up by R7 million, so feeding the trust, obviously by donating.

One can also lend money to the trust. So you could take money, stick it in the trust, also draw up a loan agreement. That loan agreement will remain an asset inside your estate. You have to attach an interest [rate] to that loan, or Sars [the South African Revenue Service] is going to deem the interest and they are going to tax you on a deemed interest if you don’t put down the interest.

And then the day that you pass away, you can either bequeath that also to the trust or the trust can pay that money back to your estate and it can be distributed according to your will. But it doesn’t make sense, at the end of your planning phase, to put in your will what X, Y, Z assets have to go to a trust, unless there is a testamentary trust for minor children – or else it’s just going to be too expensive once it goes into the trust for one. And then obviously the tax is applicable inside the trust.

BOITUMELO NTSOKO: And how does giving your children their inheritance while you’re alive affect your estate planning?

MARIUS FENWICK: I think it affects your retirement planning more than your actual estate planning. As I say, it will reduce your estate value. If you give it away, you could pay more taxes while you are alive through donation tax. That’s why I mentioned creating a loan rather than a donation. But the big thing is to be mindful of what you give away, because that’s going to have an impact on what you can earn going forward once you retire.

So as far as I’m concerned there’s a much bigger impact on retirement planning than in estate planning.

BOITUMELO NTSOKO: If you are giving away some of your assets while you’re alive, does the need for life cover decrease?

MARIUS FENWICK: What are the things on your liabilities? Life cover should only be there as a liability. And if I say liabilities, those can be in the form of liquidity that’s required inside your estate, and that required liquidity can be driven by what income your surviving spouse requires. Do you have debt, and so on? But you also increase the requirement for life cover. If the liquidity drops below a level where there’s sufficient capital to fund sufficient income, then you’ll have to look at more life cover instead of the other way around when you do proper planning and reduce your debt and your liabilities at retirement.

BOITUMELO NTSOKO: Thank you, Marius. That was Marius Fenwick, who is a certified financial planner at Wealthup.