Managing wealth sounds as though it should be easy once you have accumulated it compared to not having it.
In reality, this is far from true – we are often swapping one complex set of problems for another – that said, I have lived without money and it isn’t a great feeling and it is far from uplifting.
The more assets, pensions, property and investments you build up, the more decisions you face – and many of those decisions conflict with one another.
A perfectly sensible strategy for one objective can create a problem somewhere else.
That is one of the uncomfortable realities of financial planning.
GIVING MONEY AWAY – BUT KEEPING ENOUGH FOR YOURSELF
Take inheritance tax planning.
One of the most obvious ways to reduce the value of an estate is to give assets away during your lifetime. For many families, this can also have an immediate benefit: children or grandchildren may be able to use the money when buying a home, raise a family or build a business – money is always useful especially in the early years when it can be a struggle.
But there is a crucial question and it is not simply:
“Can I afford to give this money away today?”
It is:
“Can I afford never to have it again?”
Retirement can last for decades. Inflation can gradually increase the cost of living. Health can change. Care may be required. Homes need maintenance. Families encounter emergencies – in fact the list can be substantial, more than I dare list!
The same £100,000 cannot simultaneously be given to the next generation, retained for future security and held in reserve for later-life care.
Reducing a future tax bill may be desirable, but not if it leaves you financially vulnerable later and then it is too late – I have never heard stories of children giving the money back to the parents!
Good planning therefore requires more than identifying what can be given away. It requires thinking carefully about what should be retained.
CHILDREN MAY NEED HELP NOW – BUT LIFE DOES NOT FOLLOW A PLAN
There is a familiar argument that children need money at 35 far more than they need an inheritance at 65.
There is considerable logic to that.
A house deposit, help with school fees or support in establishing a business can make an enormous difference at a relatively young age.
But, we all know that life is unpredictable.
Money given at 35 could later be affected by divorce, a failed business or simply decisions that, with hindsight, were not successful. The money could simply be used to improve lifestyle, better cars, holidays and less budgeting to fit income earned.
Meanwhile, another child who appeared financially secure at 35 may encounter difficulties much later and then suddenly an inheritance at retirement could be a lifesaver.
Once money has genuinely been given away, it is no longer the parents’ money.
That sounds obvious, but psychologically it is not always treated that way. Families can continue to think of wealth as collectively “ours’ long after legal ownership has changed.
A gift may be entirely appropriate.
But it should usually be made in the knowledge that circumstances can change — for both generations.
EQUAL AND FAIR ARE NOT NECESSARILY THE SAME
Now consider two children.
One is financially successful, owns a valuable home and has substantial savings.
The other has experienced a more difficult financial life. Should their parents leave everything equally?
There is no financial formula that can answer that question.
An equal division may feel fair because both children are treated identically. An unequal division may also feel fair because the parents are responding to different needs.
The problem is that inheritance is rarely interpreted only as money. Children can see an estate as a final expression of how their parents regarded them.
A parent may think:
“You already have plenty, so I am helping your brother more.”
The child may hear:
“He mattered more than I did.”
Neither interpretation may have been intended.
That is why some estate-planning decisions require more than legal documents and calculations. Sometimes the most important part of the planning is the conversation.
AN INVESTMENT CAN MAKE YOU WEALTHY – AND STILL TRAP YOU
Property provides another good example.
Many people have built substantial wealth from investment property over several decades. But an asset that has risen significantly in value can create its own complications.
Selling an investment property may crystallise a capital gain and therefore potentially create a tax liability. Giving it away may also have tax consequences.
Keeping it may mean retaining an illiquid asset, ongoing management responsibilities and exposure to one particular part of the investment market.
This creates an interesting paradox.
Someone may quite legitimately say:
“I am wealthy because I own this property, but every route out of it comes with a cost.”
This illustrates an important distinction.
The value of an asset and the usefulness of an asset are not the same thing.
A portfolio worth £500,000 and £500,000 sitting in an accessible bank account are both worth £500,000 on paper but clearly they do not necessarily provide the same flexibility.
“TAX EFFICIENT” DOES NOT MEAN TAX FREE
Financial products can create similar misunderstandings.
Take a Stocks & Shares ISA.
It can provide valuable protection from income tax and capital gains tax within the ISA environment. That does not automatically make it an inheritance-tax solution.
The words ‘tax efficient’ can therefore be misleading if they are used without asking a further question:
Efficient for which tax?
The same principle applies across financial planning.
A pension may be attractive for one reason but carry different rules around access.
An investment may be suitable for estate-planning purposes but less suitable if easy access to the capital becomes important.
An arrangement designed to solve one tax problem may do nothing for another.
The label is rarely enough.
GUARENTEED INCOME – BUT AT WHAT PRICE
Annuities provide perhaps the clearest example of competing objectives.
At their simplest, they allow someone to exchange capital for a guaranteed income, usually for life and subject to the options selected.
For somebody worried about outliving their money, that certainty can be extremely valuable.
But certainty has a cost.
Once capital has been exchanged for an income stream, the ability to leave that same capital to the next generation may be reduced or lost, depending on the terms selected.
So which is better?
Keeping the capital invested, with the possibility of growth and inheritance?
Or exchanging some of it for greater certainty of income?
There is no universal answer.
One person may value security above everything else.
Another may have ample secure income already and place greater importance on flexibility and inheritance.
The financial product cannot decide which objective matters most.
That is the planning decision.
THERE MAY BE NO PERFECT ANSWER
This is why wealth management becomes more complicated, not less, as wealth grows.
You may want to:
- Reduce inheritance tax;
- Support your children;
- Retain control;
- Maintain access to your capital;
- Protect yourself against future care costs;
- Generate investment growth;
- Secure your retirement income;
- And leave as much as possible behind.
All of those objectives can be reasonable but they cannot always be maximised at the same time. That does not mean the planning has failed but it does mean choices have to be made.
THE PURPOSE OF GOOD FINANCIAL PLANNING IS THEREFORE NOT SIMPLY TO MAXIMISE INVESTMENT RETURNS, MINIMISE TAX OR PRESERVE THE LARGEST POSSIBLE INHERITANCE.
It is to understand the compromises being made – and to make them deliberately.
BECAUSE SOMETIMES THE GREATEST RISK IS NOT MAKING THE WRONG FINANCIAL DECISION.
IT IS MAKING THE RIGHT DECISION FOR ONE OBJECTIVE WITHOUT REALISING WHAT IT DOES TO ALL THE OTHERS.
Please contact NBL if you need to speak to us.
