Is intergenerational financial advice the answer?
As baby boomers reach retirement and their latter years, intergenerational financial advice might be the answer to continued business growth in the future, according to Paul Singh.
Like most developed countries, Australia is facing a conundrum – an ageing population.
In a not too distant future (2020), the-never-grow-old baby boomers will be in their 60s and 70s and the oldest of Gen Xers will be in their 50s and beginning to exit the workforce. It is estimated that one fifth of the Australian population will be over 60 by year 2020.
Putting the turmoils of the recent past (credit crunch, global financial crisis, Storm Financial collapse) aside – over the past two to three decades, growth in the financial planning industry has mainly been driven by the baby boomers.
As this generation commences its descent from the peak, financial planning businesses around Australia will face some difficult questions regarding their own mortality, in particular those considering an exit strategy in the next five to 10 years.
As baby boomers commence drawing on their retirement resources and consumption of financial products (eg, life insurance) diminishes, the impact of the ageing population will be truly evident in dwindling book values and declining funds under management (FUM).
Though, if some of the recommendations of FOFA are anything to go by, businesses planning to exit in the short to medium-term may argue that the mutiny of financial planning businesses in Australia has already begun...no need to wait till 2020.
Without a doubt, to compensate for the impact of the ageing population, now more than ever financial planning businesses need to think ‘outside the box’ and realign their business strategy with emerging markets to ensure continued growth and a successful exit strategy in the future.
One such emerging market that boasts significant value is ‘intergenerational advice’. Recent research has indicated that $600 billion will change hands between baby boomers and the X and Y generations over the coming 10-15 years.
Put simply, ‘intergenerational advice’ involves, amongst other things, financial planning and advice to facilitate transfer of family assets from one generation to another, more commonly referred to as estate planning.
This will often require involving other specialists such as solicitors and accountants. Assuming that the legalities of setting up wills, powers of attorney, etc. have been given appropriate consideration, from a practical point of view clients will often look to their financial advisers to formulate and implement strategies to meet their goals and objectives.
In the majority of cases, a client’s goals in relation to estate planning can be summarised simply as “ensuring that assets pass on to the intended beneficiaries tax-effectively with minimum delay”.
Where estate assets are easily divisible or where sufficient liquid assets are available, the task may be relatively simple.
However, in circumstances where equal distribution of estate assets is required and assets comprise of mainly indivisible assets, it may be problematic to distribute the estate equally because:
- Assets may not be easily divisible
- Particular assets may be valuable to some beneficiaries and worthless to others, and
- Capital gains tax (CGT) may be payable in some circumstances.
The need to distribute the estate equally must be carefully weighed against the desire to see family businesses continued by future generations.
For instance, in a family situation, it may be possible that some children are capable of continuing their parents’ business whereas others may have no interest in it whatsoever.
Or the business size may not be big enough to provide for all the children.
Generally, CGT does not apply upon disposal of assets by a person due to death.
However, subsequent disposal of those assets either by the beneficiaries or by the legal personal representative will crystallise the CGT liability, if any.
Let’s consider these issues in an example.
Derek is single, age 56 and operates a successful dental business. He has two children. Travis, age 25, is single and currently pursuing a Bachelor of Dental Science.
He has been assisting Derek in the management and operation of the business on a regular basis. Damien is a qualified IT engineer, age 29 and married. Damien has no intention of being involved in his father’s business.
The dental business is the only real asset that will form part of Derek’s estate and Derek would like both of his sons to receive his estate in equal shares.
Let’s assume that the business is currently valued at $500,000. The business was originally purchased in the 2000/01 financial year and the cost base is $100,000.
It is clear that Travis is being groomed as the heir of the family business in the event that Derek passes away. In the case where the business was split evenly between the two sons upon Derek’s death, the tax implications would be as follows:
Since Travis intends to continue the business, CGT will only crystallise at the time of actual disposal if there was to be one in the future.
Since the business was purchased post-1999, the indexation method does not apply. However, Derek held the business (a post-CGT asset) for longer than 12 months prior to his death, therefore Damien will be eligible for the 50 per cent CGT discount.
Discounted Capital gain: $100,000
Assuming a marginal tax rate (MTR) of 46.5 per cent, a tax liability of $46,500 will arise. In other words, the net amount received by Damien will be $203,500 as opposed to his actual inheritance of $250,000.
It should be noted that depending upon the circumstances it might be possible to eliminate some or all of the capital gain by accessing small business CGT concessions. For reasons of simplicity it is assumed that Damien is not eligible to claim these concessions.
For tax purposes, Travis will be deemed to have acquired Damien’s share of the business and the cost base for that share will be the market value of Damien’s share of the business at the time of the CGT event.
In addition, prior to embarking on a strategy, Derek should consider the following issues and their impact on his estate planning goals and objectives:
- Would Damien readily sell his share to Travis?
- Would Damien demand immediate settlement upon sale?
- Does Travis have enough resources to buy out Damien’s share?
- Would it be possible to take out a loan against the business to buy out Damien’s share?
- Does the business have enough cash flow to fund the borrowing cost?
Assuming that Travis has sufficient resources to acquire Damien’s share of the business, a simple solution to equalise the estate would be a life insurance policy on Derek’s life to cover any crystallised capital gains tax exposure.
An alternative strategic approach can be taken where Travis does not have the resources to purchase Damien’s share in the business.
In this case, 100 per cent of the business can be passed on to Travis and a life insurance policy equal to the value of the business may be purchased to compensate Damien in lieu of a share in the business.
Care must also be taken to ensure that adequate financial provision is made for all dependants.
Family law legislation in most states empowers the courts to provide recourse to certain dependants and also to determine what amounts are deemed to be adequate provision for the proper maintenance and support of the applicant.
Depending upon the facts of the case, a court may award certain amounts to applicants or rule that the estate be settled in equal proportions – regardless of the deceased’s intentions as stipulated in the will.
Conclusion
The benefit of intergenerational advice is two-fold:
- It ensures value-based financial advice to clients during the most important stage of their lives, and
- It creates a self-sufficient referral resource by tapping into generation X and Y through the current client base.
This should lead into continued growth and new business opportunities that are vital for the survival of financial planning businesses in Australia, given the consequences of ageing population.
Paul Singh is a technical consultant for practice development at Suncorp.
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