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Do You View Your Invested Assets as a ‘Piggy Bank’ or a ‘Pay Cheque’?

By Mark Barnicutt on November 12, 2015

Piggy BankMany successful entrepreneurs who’ve worked hard to build their business from the ground up sell the business for a significant sum – which becomes liquid investment assets held within financial structures like holding companies and family trusts.

These affluent entrepreneurs and their families have a new challenge ahead of them: how to sustain their assets and establish a regular cash flow payment structure for family members?

The Problem with the Piggy Bank Approach to Wealth Management

Often, affluent families treat their assets like a Family Piggy Bank, withdrawing funds as required to fund their lifestyle.

Unfortunately, this approach has two major drawbacks:

  1. Capital Impairment

Piggy banks can have negative results on a family’s long-term estate plans.

Think of it like this – if the amount of funds withdrawn exceeds the net return capability of the investments (i.e. returns = [interest + dividends + capital growth] – [fees + taxes]), the piggy bank will shrink. The assets available will shrink.

If the family’s investment advisors do not regularly measure and monitor the piggy bank, it can significantly decline in value over the course of just a few years.

  1. Increased Tax Costs

The second issue with thinking of the family’s assets as a piggy bank relates to taxes.

The family has, in fact, two piggy banks if they have a family holding company and a family trust that hold the family investments.

Do you know which of these the family should take the funds from in order to optimize their tax position and avoid paying unnecessary taxes?

In our experience helping affluent families manage their wealth as their outsourced Chief Investment Officer, this is a complicated issue. Typically, families need the assistance of a tax accountant who collaborates with their investment professionals in order to answer it in the most beneficial way possible.

Without proper planning and input from specialized advisors, the Family Piggy Bank(s) will give up a bigger share of the family’s hard-earned assets!

Why We Recommend the Pay Cheque Approach to Wealth Management

The Family Pay Cheque approach solves the problems with the Family Piggy Bank. Instead of simply taking funds from the asset pool, the wealth is managed with the family’s goals in mind right from the beginning.

Here’s how it works – the family, and their investment advisors and tax accountant collaborate from the start, helping the family quantify their cash flow requirements moving forward. Then, they design an investment portfolio/balance sheet structure that generates the cash flow required (optimized for tax purposes) using the family’s financial structures.

Now, families can see funding gaps ahead of time and avoid spending more than they can afford. For example, if a family requires $500,000 annually for lifestyle expenses, but their investment portfolios are only able to generate interest and dividends of $400,000 per year, they have a $100,000 funding gap. In the piggy bank approach, they would not realize this funding gap existed until they had already used a considerable amount of the available assets. In the Family Pay Cheque approach, they would know about this gap before depleting their wealth, and work with their investment advisors to resolve the problem.

Closing a funding gap requires the family to, once again, collaborate with their investment professionals and their tax accountant. They will need to determine any necessary trade-offs among these three potential levers:

  1. Increasing Investment Yield (without assuming risk beyond the family’s comfort level)
  2. Consuming Capital
  3. Decreasing Family Funding Needs

Typically, families do not want to consume or impair capital, as this lever has the greatest long-term effect on their family’s wealth and estate. Often, capital withdrawals are only done within the confines of a reasonable set of capital growth expectations. This leaves two other levers to consider – increasing investment yield and/or decreasing family funding needs.

When finalized, the portfolio provides a fixed, periodic set of payments to the designated family members’ bank accounts. This approach balances the funding sources with the uses for the wealth, to avoid depleting the capital or running into taxation issues.

>> HighView is an experienced boutique investment counselling firm for affluent Canadian families and foundations. We would be happy to discuss our goals-based investment approach with you and your professional advisors.

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