Many parents contemplate the prospect of transferring a portion of their estate to their children during their lifetime—particularly in difficult economic conditions where many young adults are struggling financially or could benefit from assistance to establish themselves. However, the decision to distribute wealth prematurely warrants careful and considered planning. In this article, we explore key considerations to take into account before parting with assets, along with practical options for implementing an early inheritance strategy.
What to consider before giving your child an early inheritance
Family dynamics: Family dynamics and relationships are typically complex and tend to evolve over time—and any decision you make today regarding your children’s early inheritance needs to be able to stand the test of time. Blended families, children from previous relationships, stepchildren, special needs dependants, divorce, and remarriage can make the decision-making process difficult, particularly when it comes to determining what is equitable. As relationships and circumstances change, what you once believed to be a fair apportionment may no longer feel appropriate, and this can create issues down the line.
Equal versus equitable: Many parents—especially those with multiple children—struggle to determine how best to distribute an inheritance. In this regard, it’s helpful to consider the difference between equal and equitable. An equal apportionment involves dividing assets into matching amounts, while an equitable distribution aims to achieve fairness by considering the unique circumstances of each child. For example, one child may have low-functioning autism and be unable to provide for themselves, while another is financially independent. In such cases, you may feel it is more equitable for your special needs child to receive a larger share. Conversely, giving both children an equal share may, under the circumstances, feel inherently unfair.
Inheritance is multi-generational: One of the reasons we encourage clients to involve all generations in the financial planning process is that inheritance is, by nature, multi-generational. The wealth you pass to your children won’t stop with them—it will likely flow to their children and beyond, although how that happens may not be within your control. Given this, the purpose behind the inheritance and the way it is structured become critical. Thoughtful planning can help ensure your legacy is preserved and passed on with intention.
Reasons for an early inheritance: Flowing from the above, it is important to be absolutely clear on your reasons for wanting to give your children an early inheritance, so that the structure of the bequest aligns with your objectives. Are you helping your children meet basic living expenses? Assisting them in buying a first home? Providing for a special needs child? Do you want to enjoy seeing your children benefit from your hard work during your lifetime? Do you hope to influence how the assets are managed? Or are your motivations driven, at least in part, by your own sense of fulfilment? Understanding the “why” is essential before deciding on the “how.”
Your retirement plan: Whatever your reasons, it’s vital to keep your retirement plan front of mind. You must have a robust, stress-tested retirement strategy in place before giving away any portion of your wealth. It’s difficult to anticipate large capital expenses that may arise later in life—especially the potential costs of frail care, assisted living, or private nursing. For this reason, it’s important to be cautious about what you give away, how much, and in what format, to avoid compromising your long-term financial security.
Differing value systems: Each child is different and may have a unique value system when it comes to money. One child may treasure a half-share in the family holiday home, while another—particularly one living abroad—may see little value in it. Similarly, a business that owns an investment property portfolio might seem like a valuable inheritance to you but could be overwhelming or unappealing to a child who isn’t interested in managing rental properties. Understanding what each child values can help you make more appropriate and appreciated decisions.
Open communication is essential: Whatever you decide in terms of structuring an early inheritance, it is critical to communicate openly and honestly with your children. Be clear about your intentions and explain the reasoning behind your decisions. Ideally, avoid surprises by keeping your children informed and involved in discussions, and do your best to prevent misunderstandings, resentment, or conflict from arising.
Options for giving children an inheritance
i. Donations: One method of providing an early inheritance is to use the annual donations tax exemption. South African law currently allows an individual to donate up to R100 000 per year free of donations tax. For a couple, this means a combined R200 000 per year can be donated to their children without incurring tax. Donations above the exemption are taxed at 20% up to R30 million, and at 25% on amounts above that. This strategy is ideal when a child needs temporary financial support or when you wish to contribute toward a grandchild’s education.
ii. Loan agreement: If you intend to transfer a larger sum, it may be more effective to structure it as a loan. The loan amount will reflect as an asset in your estate and will not attract donations tax. In your Will, you can stipulate that the loan be written off upon your death. This can work well if you want to help your child buy a home or start a business, without creating a donations tax liability.
iii. Living trust: An inter vivos trust (also known as a living trust) is another effective way to gift assets during your lifetime. These trusts—whether vesting or discretionary—are often used to hold long-term growth assets such as property or investments intended for future generations. The asset is typically sold to the trust, and the proceeds reflected as a loan from you to the trust. The value of the asset appears in your estate at its sale value, but any subsequent growth takes place in the trust and falls outside your estate for estate duty purposes. However, once the asset is transferred, it is important to keep in mind that you must relinquish full control of the asset. The trust’s appointed trustees manage the asset according to the trust deed in the best interests of the beneficiaries. As such, it is essential to fully understand the legal and financial implications of this arrangement and to ensure that your trustees are competent and aligned with your intentions.
Have a fabulous day.
Sue
