Many parents toy with the idea of gifting their children some of their inheritance while they are still alive, especially in tough economic times where many young adults are battling the make ends meet or could benefit from some financial assistance as a means to getting ahead. However, giving away some of your wealth while you are still alive is something that should be undertaken with the utmost caution. In this article, we unpack several factors that should be considered before parting with your wealth, together with options for effecting an early inheritance.
What to consider before giving your child an early inheritance
Family dynamics
Family dynamics and relationships are typically complex and tend to change throughout one’s lifetime – and you need to be sure that any decision you make today regarding your children’s early inheritance can stand the test of time. Blended families, children from a previous relationship, step-children, special needs children, divorce, and re-marriage, can make the decision-making process difficult to navigate especially when it comes to determining what is equitable. As relationship dynamics evolve over time, it is possible that what you once thought was a fair apportionment is no longer palatable, and this can cause problems in the future.
Equal versus equitable
That said, many parents – especially those with multiple children – battle to determine how best to distribute an inheritance amongst their children. In this regard, we often advise our clients to first consider the difference between equal and equitable. An equal apportionment means dividing the assets in matching amounts amongst one’s children. On the other hand, an equitable apportionment is designed to achieve a proportionately fair inheritance for each child. For example, one of your children could have low-functioning autism and will never be able to provide for herself while the other child is highly qualified and financially independent. In such circumstances, you may believe it equitable that your special needs child is given a greater share than her sibling, and that giving each child an equal share may be considered to be unfair.
Inheritance is multi-generational
One of the primary reasons that we believe so strongly in involving all generations in the financial planning process is because inheritance is multi-generational. Whatever you choose to bequeath to your children does not stop there, but rather flows to the next generation and the next – although how this happens may not always be under your control. Because your assets will ultimately flow down through multiple generations, the underlying reason for the inheritance and how you construct the inheritance are paramount.
Reasons for an early inheritance
Flowing from the above, it is therefore important to be absolutely clear on your underlying intentions for wanting to give your children an early inheritance so that the structure of the bequest is fully aligned. Do your children need financial support to cover their living expenses? Do they need help purchasing their first home? Do you have a special needs child that needs to be supported financially? Do you want to enjoy seeing your children benefit from your hard work while you are still alive? Do you want to control the way in which they manage the assets you intend to give to them? To what extent is your ego involved in your desire to transfer your wealth to your children while you are still alive?
Your retirement plan
Whatever is driving your desire to give your children an early inheritance, do not lose sight of the fact that your retirement plan remains your priority and it goes without saying that you need to have a robust, stress-tested retirement plan in place before you can even contemplate giving away any of your wealth. Early on in retirement, it can be very difficult to budget for large capital expenses that you may be faced with later in retirement, or the costs of frail care, private nursing or assisted living should your health deteriorate later in retirement. As such, it is advisable to be very careful of what you give away, how much you give away, and in what format you do so.
Differing value systems
All children are different and are likely to have different value systems when it comes to finance. While one child may be delighted to inherit a half-share of the family holiday home, your other child who lives abroad may find no value in owning a share in the property. Similarly, bequeathing your child a business that owns an investment property portfolio may seem like a prize inheritance, while the management of rental property may be very unappealing to your child.
Open communication is essential
Whatever you decide in terms of structuring your children’s early inheritance, it is critical to remain open and honest about your intentions and to be clear on the reasoning and logic you used when making your decisions. Ideally, avoid surprises by ensuring that your children are kept abreast of the plans and discussions, and do everything possible to ensure that no resentment or anger arise.
Options for giving children an inheritance
(i) Donations
One method of gifting your children an early inheritance is to make use of the Category 3 donations tax exemption which allows an individual to donate up to R100 000 per year without paying donations tax. Remember, donations tax applies to any individual, company, or trust at a flat rate of 20% on the value of the donation up to R30 million, and at a rate of 25% thereafter, subject to the annual R100 000 exemption. This means that you and your spouse can donate up to R200 000 per year to your children without incurring a tax liability. This method would be suitable in circumstances where a child requires financial assistance to tide him through tough times or where you would like to donate towards your grandchildren’s tertiary education.
(ii) Loan agreement
If you intend to gift a larger amount of money to your child, it may be more effective to structure the inheritance as a loan whereby the loan account appears as an asset in your estate, thereby avoiding donations tax. In terms of your Will, you can then stipulate that your child need not pay back the loan. This could work well where, for instance, you would like to help your child purchase their first home but don’t want to create a donations tax liability.
(iii) Living trust
An effective way of gifting assets to your children while you are still alive is through an inter vivos trust structure, either vesting or discretionary in nature. An inter vivos trust is an effective way to house and preserve growth assets intended for your children and future generations, such as the family holiday home. To do this, you would need to set up a living trust and sell the intended property to the trust, following which the loan would reflect as property in your deceased estate. As a growth asset, the value of the property held in trust is likely to continue to grow over time, although the value of the property will appear in your estate at the selling price. As a result, all growth in the value of the asset will take place in the trust and will not attract estate duty in your deceased estate. However, remember that transferring an asset into a living trust requires that the trust founder relinquishes full control of the asset and that it is the role of your nominated trustees to manage the asset on behalf of the trust. It is therefore essential that you are fully aware of the legal and financial implications of losing control of the asset in favour of the trust.
Have a great day.
Sue
