Whether it’s the sight of Logan Roy foaming at the mouth at his conniving, inheritance-sucking kids in Succession or the recent Federal budget, which outlined new rules around intergenerational business transfers, the passing down of family wealth is a core part of a good financial plan.
And yet, given its emotional importance and the amount of money often at stake, the success rate is pitiful. Seventy per cent of families report failure1 when it comes to intergenerational wealth transfers. It’s a core part of many people’s financial plan and yet 67% cite it as their biggest concern.
Why is the failure rate so high? Maybe families aren’t getting the right advice, but this statistic also taps into human behaviour. As a rule, we aren’t comfortable talking about death, especially our own. For those with significant assets, including a business, to leave behind, this spells potential disaster.
A pulse survey of investors in Alberta by ATB Wealth in 20191 found that one-in-five were uncomfortable planning for or talking to their family about their death, although 63% had created a will for peace of mind. The survey also revealed only 39% had discussed the document’s financial impact and, among those with children over 18, just 28% had introduced their children to their financial advisor.
It doesn’t take a Warren Buffett-sized brain, therefore, to realize all this makes a “shirtsleeves to shirtsleeves in three generations” scenario – the inability of families to efficiently pass down their riches – more likely.
A total of 72% failed wealth transfers are attributed to a breakdown in communication2, so talking openly about the situation and the plan is, therefore, vital. But you don’t have to be as emotionally repressed as Logan Roy’s brood to find this challenging. Talking to your children about what happens when you die, whether it’s who gets The Beatles record collection or how the entire estate is to be divided up, is hard.
That’s where an ETF Capital Management, Certified Financial Planner (CFP), can help the process. They can help facilitate regular formal meetings – often referred to as family governance – to help make important decisions and involve all generations in the process. Of course, things change, so a succession plan should be a living document, which establishes the priorities for various family members. For example, what does the family wealth mean to them? Who is genuinely willing to take over the family business? What is the best age for children or grandchildren to inherit assets? How can they protect these assets through life events?
Trends suggest that the younger generation are more ESG inclined, while women lean towards philanthropy. Getting everyone around the table as early as possible to understand, and plan for, these potential differences is vital.
Not only is there a startlingly low 30% business transfer success rate but, according to the Exit Planning Institute, 83% have no written transition plan3. Presumably, then, a key question is not given enough prominence: who is going to take over? This may be an obvious family heir or a third-party candidate, or a sale may be the answer. Either way, family meetings should involve honest conversations about who is actually keen to take over. Kids often go along with their parents’ ideas, but the reality may be an unwanted burden.
Preparing the next leader can also take years so this can’t be a last-minute decision. Gradually introducing them into the decision-making process or client meetings, for example, will smooth out the process.
Once a successor is identified, tax considerations are paramount. The latest federal budget proposed changes to Bill C-2084, which was adopted in June 2021 and was designed to close a loophole that made it more financially beneficial for a small business to sell to a stranger rather than a family member. Previously, the difference between original price and sale price was considered a dividend but a sale to a non-family member qualified this for capital gains at a lower rate. The Bill effectively allowed both to be treated as capital gains.
However, the way it was written created another loophole in that the legislation didn’t require the child to have any involvement in the business. Therefore, the parent could reduce their tax bill but keep running the company. The latest change puts a stop to this. The corporation buying the business will have to be controlled by an adult family member of the seller if the seller wants to claim the transfer as a capital gain.
As with this important development, minimizing capital gains tax is a tenet of a succession plan. Doing this well in advance can not only ensure you pay less but avoid the disastrous scenario where a family can’t afford to pay their capital gains tax bill.
Here are two strategies to consider:
For small business corporations, you can claim a lifetime capital gains exemption to reduce this tax. The exemption is $971,190 in 2023, meaning a gross gain of up to this amount is tax-free. The exemption is indexed to inflation. To be eligible, the asset must meet certain criteria, including that you owned it for the past 24 months and at least 90% of the assets are used for business primarily in Canada.
This strategy locks in the gain, and capital gains tax, based on the company’s value. Typically, the owner exchanges their common shares for fixed-value preferred shares, and then issues common shares to their children. Any future growth in the company’s value goes to the common shares and isn’t taxed until their children in turn sell or gift their shares, which can avoid a huge capital gains tax bill and benefit the successor.
The transfer of wealth requires planning and the transfer of a business arguably more so. The above are just some of the key considerations. Speak to a CFP to see what is most efficient and effective for your situation.
One thing is applicable to all cases: a successful transfer will depend on how prepared the next generation is. Don’t let family dynamics fester like the Roys or wait until it’s too late to get your plan in place. Failure to do so could seriously damage your family’s wealth.
2 Castoro, A. & Williams, R. (2017). “Bridging Generations: Transitioning Family Wealth and Values for a Sustainable Legacy.”