The Piggy Bank vs The Pay Cheque

OVERVIEW:

One of the challenges that many affluent families face is establishing a regular cash flow payment structure for family members, which I refer to as ‘The Family Pay Cheque’.

Specifically, often after the sale of a business, the successful entrepreneur will now have a considerable amount of liquid investment assets sitting within their various financial structures such as holding companies and family trusts.  In order to fund their lifestyle, families will often simply withdraw funds as required.  In other words, they are simply reaching into the ‘Family Piggy Bank’ and taking funds as needed.

THE PIGGY BANK CHALLENGE:

The challenge with the Piggy Bank approach is two-fold:

1. Capital Impairment: If the amount of funds withdrawn over time exceeds the net return capability of the investments (ie: interest + dividends + capital growth – less fees and taxes), the Piggy Bank will start to shrink in size.  If not measured & monitored on a regular basis by a family’s investment advisors, Piggy Banks can experience significant declines in value over several years, which can then negatively impact long-term estate plans.
2. Increased Tax Costs: Also, if a family has a family holding company and a family trust that holds the family investments, they actually have two Piggy Banks.  So, from which Piggy Bank should the family withdraw funds in order to optimize their overall family tax position?  Our experience is that this is a complicated answer which requires the specialized assistance of a tax accountant working in collaboration with the family’s investment professionals.  If not planned effectively, the government will end-up taking a needless bigger share of the Family Piggy Bank!

THE PAY CHEQUE SOLUTION:

The solution to the Piggy Bank problems is the Family Pay Cheque.  In this approach, investment & tax accountant professionals collaborate with the family to quantify the cash flow funding requirements of the various family members and then design an investment portfolio/balance sheet structure that can provide the cash flow generation that a family requires in a tax optimized manner via the applicable family financial structures (ie: holding companies, trusts, etc.).

As this approach is effectively a ‘Sources & Uses’ exercise, the Funding Sources need to balance with the Uses.  For instance, if a family needs $500,000 in annual funding for lifestyle purposes but their balance sheet/investment portfolios are only capable of generating interest & dividends of $400,000 per year, then there is $100,000 funding gap.  To close the funding gap requires a collaborative discussion amongst the family, investment professionals and tax accountant, which always involves a set of trade-offs amongst three potential levers:

1. Increasing Investment Yield (without assuming risk that is beyond the family’s tolerance), and/or
2. Consuming Capital, and/or
3. Decreasing Family Funding Needs

As most families don’t want to impair capital, any capital withdrawals are typically done within the confines of a reasonable set of capital growth expectations, so that long-term family financial capital is not impaired.

BENEFITS OF THE PAY CHEQUE APPROACH:

Once finalized, the appropriate administrative processes are established to provide a fixed, periodic set of payments to the bank accounts of the applicable family members, which we refer to as The Family Pay Cheque.  By adopting this approach, families are better able to preserve their long-term capital value and optimize their after-tax returns across their various financial structures.