The expression "from shirt-sleeves to shirtsleeves in three generations" refers to families that don't look after their money and investments properly.
A shopkeeper doesn't go to lunch and leave the cash register unattended. A company doesn't leave its finances to chance either - it will have a CFO and an accounting department. Families are no different - they need to look after their finances.
Sometimes it isn't easy - the head of the family may be too busy and/or lack financial experience. But nearly every family needs to plan and control a number of things, including: investments, philanthropy, estate and succession planning, real estate for living and investment purposes, kids/ education, vacations, the next automobile and so forth. In addition, advice will be needed from time- to-time about investing, legal matters and tax planning.
For wealthier families a "family office" is vital.
Andrew Carnegie made his fortune from steel in the nineteenth century. As far back as 1889, Carnegie wrote: "The problem with our age is the proper administration of wealth."
Early examples of the family office in use include the Rockefeller and Getty foundations. In the 1980s the family office concept became well-established for less wealthy families in the US and elsewhere.
So what is a family office? A family office is any facility dedicated to managing and growing family wealth. Some have an office with employees. Some use a bank trust department. Others make periodic use of a team of external advisors consisting of a banker, an investment advisor, a lawyer and an accountant and others, as needed.
If your team is smart and proactive, their benefit to you should far outweigh their cost.
One or more trusts or investment holding companies may also be set up by the family to hold investments. However it is constituted, a family office has a number important functions, including monitoring and administering investments and dealing with personal outlays.
What are the advantages of a family office?
A properly run family office can help in a number of ways including: managing wealth soundly; passing wealth to the children and preparing them; maintaining privacy; planning business ventures and other financial needs; pooling the family wealth to achieve economies of scale and better returns; facilitating philanthropic support and donations; facilitating tax planning and monitoring; and indicating the family is well-organized. Here is a hypothetical case study.
Moshe and his wife are both US citizens residing in Israel with cash of $2 million to invest for the long-term. Their family office reviews various possibilities. Eventually, Moshe and his wife each decide to invest $1 million in a "second to die" life insurance policy that is compliant with US legislation from a reputable insurer for the benefit of their children. After both die, the investments have grown to $4 million but the policy pays out $6 million. In this way, US estate tax may be avoided and the Israeli tax on the income element (20% of $2 million) may apparently only be $400,000. Nevertheless, detailed professional advice is needed regarding all the above aspects and to check there will be no other implications (such as 25% Israeli withholding tax in certain cases, 15.5% Israeli VAT in certain cases, 1%-3% US excise taxes at the outset). Other alternative courses of action should also be evaluated.
How do you implement a family office?
This necessitates a policy decision, appropriate computer systems and specific procedures - family council meeting every three-to-six months and consultations/correspondence with advisers between meetings. A steering team should be established consisting of professional, financial and family representatives. Their role is typically to interface and coordinate things together; monitor developments regarding investments, family developments, legal and tax changes in each country concerned; arrange the family council meetings; follow up on agreed action items; report back at the next family council meeting. A financial record system should also be maintained. Therefore, decide whether this will be done by a bank, financial adviser or accountant; decide where input and storage will be; arrange a communication system including, perhaps, a secure Web site; decide which financial reports to prepare and circulate.
What needs to be discussed?
A typical family office council meeting agenda will cover both short-term and longer-term subjects. Short-term subjects include: the latest cash position; latest business position; recent investment performance; real estate matters; family needs; economic and political climate; private assets - home, art collection, automobiles etc; tax and legal matters; action items; next meeting date.
Longer term subjects for discussion at the family office council meeting may include: general goals; tax strategy; estate and gift planning; grooming the next generation to handle business and investment matters; buying or selling assets; life and health coverage; school and university needs; relationships with banks, professionals, governmental and other persons.
What are the typical issues with a family office?
Having established that a family office is good for guarding family wealth, you need to be ready for issues that may arise. Who should be the members of the family office (family members, external advisors)? Which structure makes most sense (ad hoc team, company, trust, foundation, combination of these, etc)? How to handle possible discord within the family? Also, at the technical level, investment reports need to be adjusted for consistency - same currency and reporting period, and net returns after all costs and taxes. On the tax front, Israelis usually check out income and capital gains taxes, but often overlook foreign estate and inheritance taxes.
To sum up, wealth preservation isn't automatic. Have a family office that suits you to help look after your personal finances, take care of taxes and reduce hassle.
Leon Harris is an international tax partner at Ernst & Young Israel