Succession: beating the third generation ‘curse’

It can take a lifetime of hard work and dedication to build family wealth - but just two generations to lose it.

It’s not uncommon for a family’s third generation to find themselves back where their grandparents started but it’s a fate that can be avoided with careful planning.

Being able to pass along wealth is a tangible way for some New Zealanders to leave a legacy and help children and grandchildren be better off financially.

Sadly, about 70% of a family’s wealth is squandered by the second generation. By the third generation it’s 90%, according to a widely quoted longitudinal study of 3,250 families conducted over 25 years by US wealth consultancy The Williams Group in 2002.

In simpler terms, this research shows only one in every 10 families can expect to see their wealth last beyond their grandchildren’s generation.

There are a few theories for this widespread phenomenon, from the first generation failing to get their estate planning in order, to the third generation being clueless about money.

But one thing is certain: anyone hoping to make their wealth last more than three generations needs to make a plan.

The ‘shirtsleeves to shirtsleeves’ problem

This rapid erosion of wealth is so well known that it has its own Chinese proverb: wealth doesn’t pass three generations. It’s also spawned a saying in English: ‘From shirtsleeves to shirtsleeves in three generations.’

There are some cogent theories. One is each subsequent generation has less understanding of the work involved in building and maintaining wealth than the previous one.

The generation that first builds wealth does so through grit and determination, according to this theory. In pulling themselves up by their bootstraps, they understand the value of their work and wealth more deeply.

The next generation still has some idea of the trials their parents went through to build the family’s wealth. They may have childhood memories of the long hours and dedication of their parents to get ahead. Although they’re accustomed to a better quality of life, they know wealth isn’t cheap and so are relatively savvy with their money.

The third generation, however, will have grown up exclusively in the lap of luxury and have no reference point for the labour of their parents and grandparents. As a result, the value this generation places on money and wealth is significantly less than those who came before.

How families leave lasting legacies

Some families have successfully broken this ‘third-generation curse’ to create truly lasting wealth for their heirs, but how?

A common characteristic among these institutionally wealthy families is they see themselves as custodians of their family’s assets. Although they benefit from this wealth, it’s not exclusively theirs. Instead, this wealth is part of a larger legacy they have a duty to maintain.

Importantly, they’re also more likely to plan ahead – and plan early.

One of the biggest challenges newly wealthy families face is the entrepreneurial mindset – which may have helped them build their wealth – doesn’t lend itself to estate planning.

Wealth creators often find success because of their focus on and commitment to their business rather than a dedication to making money. They are often willing to take risks for the right rewards and they back themselves to make the right decisions.

Making wealth last, on the other hand, requires giving some attention to the wealth itself, not just the work which created it. And while it’s reasonable to take on some risk when managing a portfolio, these risks may not be as great as an entrepreneur might take with their business.

It can also be difficult for these wealth creators to acknowledge their own mortality. Some believe they still have decades to plan their wealth transfer - even into their 70s.

ANZ recently undertook research into inter-generational wealth transfer and the conclusions were fascinating. 

Here are some key considerations for making wealth last.

Family make-up

Modern families are dynamic. Hook-ups, break-ups, births, deaths and divorce can have confusing consequences for your wealth plan. You’ll need to consider how your family’s composition might change in the future and how you can safeguard your vision for your wealth in the face of those changes.

Tax structures

Depending on how your assets are held and transferred, the tax bill associated with your wealth transfer can vary wildly. For example:

  • Gifting some of your wealth prior to your passing can reduce the tax owing on your transfer.
  • Holding your assets in a company structure will mean you pay tax at a corporate rate instead of the often larger individual rate.
  • Assets held in trusts are usually taxed in the hands of their recipient in the year that money was earned, irrespective of when the income is paid to the beneficiary.

Importantly, the benefits afforded by each different structure often come with a trade-off. Using a company structure, for instance, may lower the tax paid on assets held within it but will mean forfeiting the 50% capital gains discount applied to assets held longer than 12 months.

These structures can also play an important role in asset protection. Placing assets into a company structure, for instance, can enable greater flexibility to transfer ownership of shares in the future while a testamentary trust can provide greater surety assets will be inherited by a specific beneficiary.

A trusted adviser

An important step towards preserving family wealth over several generations is putting a wealth transfer plan in place. A trusted, qualified adviser, such as private banker, can help you facilitate conversations with your family. Planning ahead can help your family avoid becoming a statistic in the three-generation curse!

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