DEATH is an eventuality that most of us are reluctant to contemplate. For wealthy families in particular, it attracts a host of challenges central to the issue of how wealth can be preserved and passed down to future generations.
Failure to plan can eventually destroy wealth, as funds could be jeopardised by multi-jurisdictional claims such as offshore taxes, for instance, and claims or challenges arising from divorce or family disputes.
In Singapore and parts of Asia, such as Hong Kong and Malaysia, estate duty is no longer charged. But the need to plan remains uppermost, particularly when wealth is substantial. It has been estimated that some 80 per cent of wealth in the Asia-Pacific will pass to the next generation over the next 15 years.
Research by Capgemini in 2011 proffers some sobering findings. Its survey of the Asian wealthy found that while 22 per cent of high net worth individuals in Asia-Pacific ex-Japan believe that succession planning is important, 88 per cent believe that the next generation will not be able to adequately manage inherited wealth.
The study pointed out that the statistics so far on the longevity of Asian family businesses are disheartening: About 30 per cent of family businesses survive into a second generation; and a mere 10 per cent into the third.
Says Lee Woon Shiu, Bank of Singapore managing director and head of wealth planning, trust and insurance: "Clients from different regions have different concerns. Clients from China and some of the emerging markets are concerned about confidentiality and asset protection. That's because they're first-generation wealth and have not seen huge amounts of wealth in their lifetime until now. They look for avenues within legal parameters so they don't lose sleep at night worrying about funds for the next generation.
"You can also find relatively more mature (wealth) markets in Asia where families have had their wealth for generations. Such families are typically quite traditional and talk about family values. They ask us to suggest ways to put in the right structure to make sure collective family values can be forged."
The clear message is that a discussion on succession issues should take place. At Bank of Singapore, this is pursued among 80 per cent of clients.
To be meaningful, the discussion on succession planning is likely to be personal - often, intensely so. More than one meeting may be needed. Clients will need to be prepared to be open on key issues such as the family business, an inventory of assets, and their needs or desires in terms of provision for family members. A banker may be present at the meeting, as well as a trust services adviser and lawyer.
In a column published earlier in The Business Times, Mr Lee wrote that the family must first identify the capital it has amassed, not just financial but also human and intellectual capital, as well as the core values that sparked the creation of capital in the first place. "Once these have been clearly identified, the family must then create an estate plan bound by a system of family governance to assert the shared values and goals of the family across generations."
Mr Lee writes that in the planning process, the family must bear in mind the exposures including the nationality/ residency/domicile status of family members and beneficiaries; the jurisdiction of the locality and nature of the family assets; the profile and existing and projected needs of family members as well as longer term aspirations and needs.
The nationality/residency/domicile status is particularly important for its estate duty implications. The US estate duty and UK inheritance tax are 45 and 40 per cent respectively. Even if no family member has a US domicile or residency, US and UK property will attract estate or inheritance taxes. "As Singapore clients buying properties in London, if the property exceeds £325,000 (S$632,000), a 40 per cent inheritance tax has to be paid to the UK government," he says. In the US, the exemption threshold is even lower at US$60,000. Once a property's value exceeds that, it attracts US estate tax.
There are a number of instruments that may be used in estate and succession planning.
One such instrument is trusts, which are legal vehicles to hold assets for the benefit of third parties. A trust is created by a settlor, who may be the patriarch or matriarch of the family and the creator of family wealth. Through a trust, the settlor is able to specify beneficiaries, make investment decisions, and specify the manner and duration of distributions. Under the current Singapore law, a trust may have a lifespan of up to 100 years.
Mr Lee says: "Typically the older generation is very averse to talking about death. If they can't get past the psychological threshold, doing a trust may worry them even more. But in most cases, a trust is appropriate. Once you understand that a trust is not there to be a roadblock but to enhance the ring fencing and succession planning, they accept it."
There are a number of misconceptions surrounding trusts that advisers will have to address with clients.
One misconception is that trusts are restrictive. Two to three decades ago, this was indeed true. On investments, a trustee was permitted to invest trust funds in a restrictive list of conservative investments. However, the Trustees Act, passed in December 2004, made a number of changes. On investments, for instance, it did away with the investment list. Today, investments may involve assets that do not generate income such as art work, antiques and other collectibles.
Today, clients - who are typically the trust settlors - can have investment powers. Chee Fang Theng of Pan Asia Wikborg Rein LLC says: "It's very common for the settlor (client) to reserve investment powers. Section 90 (5) of the Trustees Act specifically provides that this will not invalidate the trust."
However, reserving too much powers to the settlor runs the risk of invalidating the trust. Settlors must still relinquish control. There is therefore a balance to be struck. "If the settlor reserves too much powers, then the question is whether this would affect the validity of the trust, or if the settlor is truly still 'in control' of everything, which is antithetical to the core concept of a trust.
"One option is for the trustees to have the power to change or remove beneficiaries, but for this power to be exercisable with the concurrent consent of the settlor, so it is not the settlor who makes the sole decision on such issues," says Ms Chee.
A second misconception is that some clients may expect a trust to be effective immediately in terms of its ability to withstand claims from creditors and other parties such as an ex-spouse.
Says Mr Lee: "Some people think - 'I'm getting divorced tomorrow. I can set up a trust now and it would work'. But by then, it's too late. If the intent is to escape from legal obligations, it won't work. In the case of bankruptcy, most countries such as Singapore have a clawback period of five years. Clients must think and start planning when things are rosy. If they wait till things turn sour, it may be too late."
Sim Bock Eng, Wong Partnership partner and deputy head of banking and financial disputes practice, says there are aspects of trusts that clients must not take for granted.
One is that even with planning, tax may still be payable to some jurisdictions, she says. "Trust is a creation of the law and while it is a common vehicle for wealth transfer, it is not recognised by all countries . . ." Some countries such as France and Indonesia have not become signatories to the Haque Convention on Law Applicable to Trusts and their Recognition.
"In these countries, the trust may not have the effect of preserving wealth or reducing and avoiding taxes which may be payable," she says.
Trust structures must also allow some flexibility for review as circumstances change. "Clients often believe that once a trust is set up, or they have planned their estate, the work is done and the trust and estate planning will go on to achieve their intentions. They overlook the fact that while the trust may work as envisaged, the beneficiaries, family circumstances and legal or economic environment may change.
"The more prudent of settlors will . . . allow some tweaking and adjustments in their lifetime, and establish the parameters for any changes which may be necessary in the administration of the trust, with the trustee."
Confidentiality also cannot be taken for granted. Ms Sim says that clients often believe that the confidentiality of trust provisions and the trustee exercising discretion will go some way to preserve family harmony and discourage disputes as ". . . the beneficiaries cannot fight for what they are not aware of".
"Such confidentiality is however not absolute. There are instances where the court has, on application of the beneficiaries, required the disclosure of the letter of wishes, and disputes by beneficiaries are not unheard of."
There are a number of other important considerations in structuring a trust. One is the trust jurisdiction, which should be stable and a place where the rule of law prevails. On trust services providers, it is important to pick a company with staying power, and the resources and infrastructure to ensure data security and protection, for instance.
Some clients may be concerned about fees. Some trust service firms begin to charge a fee only when the settlor dies. Others, such as BOS' trust service firm, charge a fee from the time the trust is established. Its fee is quoted as a flat fee.
Mr Lee says: "In our opinion, the trust has to be active from day one. Asset protection benefits are real, which clients enjoy in their lifetime. For this reason, we believe the fees have to start running so we can give the best input and advice from day one, and not only when (the settlor) passes away."
Jumbo life policies
Large insurance policies or universal life plans may be recommended for wealth structuring. These policies are offered by a number of insurance firms, where returns are linked to a quoted crediting or interest rate.
Apart from the life protection it provides, Mr Lee says the policies can also be used as a tool for wealth equalisation. As an example, a business owner may want to distribute his wealth of $20 million equally to his two children. But the bulk of wealth is tied up in the business which is run by a son. Giving the daughter a half-share in the business may not be prudent or feasible.
"What the father can do is to purchase a $20 million policy on the father's life, which can be put into a trust. When he passes, the $20 million payout can be paid into the trust for the daughter's benefit.
"The beauty is you don't have to create $20 million from scratch. For a man in his 40s, a $20 million policy may cost $4-5 million in premiums. So we can use a relatively small amount of cash to create large insurance proceeds for the benefit of the children later."
Another example of its use relates to the creation of liquidity upon the settlor's death. Mr Lee says business owners may take up loan facilities in the course of their business, where the loan agreements have default clauses that empower the bank to call on the loan once the business owner dies. The family may have no access to huge pots of ready cash. Because of the triggers, the family wealth may be in jeopardy.
A universal life policy can be purchased and held in a trust. Upon the death of the business owner, who is the life insured, the family will be able to receive the death benefit out of the trust, and use the proceeds to pay creditors. "Most of the time, the family has the wealth to settle with creditors, but they need time to liquidate assets and sometimes the banks can't wait," he says.