March 6, 2018
A survey in the US shows that 70% of wealthy families lose their wealth by the second generation and about 90% by the third. Translating this statistic to Nigeria, we can safely estimate that 90% of wealthy Nigerian families lose their wealth by the second generation as recent findings show that only a few Nigerian families have successfully transferred wealth to the third generation.
Today, the average High Net-worth Individual (HNI) is more focused on legacy building as a means of wealth preservation to avoid the dreaded “shirtsleeves to shirtsleeves in three generations” phenomenon, whereby, historically, it has proved very difficult for a family to maintain its wealth from grandparents to grandchildren. For varying reasons, it just so happens that the hard-earned wealth in the first generation is dissipated by the heirs at a stunningly high rate in the second generation, with only volumes of stories of “good old days” handed over to the third generation.
Effective Wealth transfer in this present clime appears more delicate and almost self-defeating as the average HNI is nearly 60 years with over 60% of this demographic being self-made, it is likely that any given individual within it will be party to, or be considering the transfer of significant wealth in the next two decades to their Children who are Millennials — the tech-savvy, environmentally aware generation born in the 1980s and 1990s, with varying ideas and beliefs about wealth.
The above raises the questions “how can family wealth be transferred, preserved and grown from one generation to another whilst keeping their family intact? And more importantly, how can the wealth be transferred across generations in the most tax efficient manner? This article discusses fundamentals of wealth transfer, including reasons for unsuccessful multi-generational wealth transfer and key issues to consider in ensuring efficient wealth transfer.
There is no single approach to wealth transfer. The process of selecting a wealth transfer method is quite unique to every family, and as such must be customized to complement each family’s needs and objectives.
The globally recognized methods can be housed under two main categories: conventional method and modern method. The conventional method involves adoption of testate succession (e.g. will/testament) and intestate succession (e.g. customary law of inheritance), while the modern methods involve the use of more sophisticated tools such as private trust, investment holding companies (IHC), foundations, conditional sale of assets, etc.
The use of conventional methods of wealth transfer is beguiled by numerous shortcomings and in most cases fail to preserve the wealth being transferred. For instance, the receiving generation in a will/testament arrangement are exposed to an estate fee at the rate of 10% of the asset value before a probate letter can be approved for the asset transfer by the Probate Registry. Again, when perfecting title to the asset, the receiving generation will be exposed to additional processing fee that may be as high as 15%, depending on the State where those assets are situated. The probate process is also quite cumbersome and there may be difficulty in determining assets owned by the deceased. It is also more difficult to check or prevent assets mismanagement by the receiving generation.
In the modern methods, the lapses from above are better managed. For instance, the use of trust eliminates the need to go through probate process and hence, helps to avoid estate fee charges. It also better manages family disputes that may arise from ‘property sharing’ as the assets are technically owned by the trust, with only beneficial interest in the assets accruing to the receiving generation.
Each method has its individual characteristics, benefits, drawbacks and tax implications with some generally being advantageous than others. For example, a trust construct potentially offers better tax shield than use of IHC as beneficiaries in a trust arrangement are taxed at a lower rate than IHC. Certain foreign-earned income such as rent, dividend, interest, can also be tax-exempt in the hands of the trust or IHC.
The conventional method is widely common in Nigeria but has become archaic, costly and even tax inefficient. It also leads to numerous family disputes. The application of sophisticated tools in the modern methods curbs the inefficiencies of the conventional method and a more seamless and efficient wealth transfer process can be achieved.
After deciding, following advice from professionals on the wealth transfer method to adopt, it is important to consider how to ensure there will be wealth to transfer to the next generation in the first place.