With the increasing demand for risk control and family inheritance, the family trust, which is long-standing and well-established in foreign countries, has begun to attract Chinese entrepreneurs. With thorough planning, it addresses the highest-level demands of a family, and effectively solves problems related to preservation and family wealth inheritance as top levels in the structure of the family wealth management system.
From the perspective of family wealth management, banks take charge of cash flow; insurance companies are responsible for capital management related to the life, time and value of family members; family trusts administer family wealth passed from generation to generation with more rigorous, meticulous and customized planning, establishment and operational requirements.
Understanding How Family Trusts Work in China
The Chinese trust market is still in its initial stages of development. Most people do not have a thorough understanding of family trusts and tend to confuse them with trusts and financial products, so at the beginning, they tend to ask questions about how much should be invested, or whether the income is guaranteed. People compare different trusts and financial products by their return rates. It seems to be straightforward but, in fact, different products may consist of different contents due to their different assets, and they cannot be compared with each other.
While designing clauses for family trusts, most clients and trust institutions place exclusive emphasis on expenditure, such as offering beneficiaries educational expenses, or initial expenditure for starting businesses, or funds for marriage. It’s nothing but a series of cash outflows. Few take into full account how to ensure the family trusts’ sufficient cash inflow to compensate for all possible expenditures arising from an increase of family members, tax increases, etc. Once the cash flow is interrupted, the family trust may come to an end quickly.
As for family trusts, we must understand that they are not designed in nature as a financial product to help clients gain benefits, but as a financial tool to isolate wealth from risks and to implement long-term management and the reasonable allocation of wealth. Besides, a single trust product cannot solve complicated family wealth problems. Instead, the family office offers clients a set of family trust system solutions to satisfy demands, integrate resources and form a sound cycle.
How can one ensure the smooth operation of the family trust system and sustain a family’s prosperity under guidance based on understanding? This topic will be further discussed below.
- Demand-oriented structured thinking and flexible combinations
For high net-worth clients with a certain extent of asset accumulation, the return rate for family wealth management is only a shallow demand because their ability to create wealth is much better than financial products. Entrepreneurs prefer family trusts mainly because they can satisfy many of their practical demands, such isolation of risk, confidentiality of properties, reasonable tax savings, flexible allocation, arrangement of inheritance, and charity planning.
If you compare the family wealth of a client to a “capital pool”, trusts and financial products from different financial institutions are like “containers” with fixed structures. Financial advisors use such “containers” to constantly “fetch water” from clients’ capital pool. Due to limited capacity, however, the demands of clients cannot be always satisfied. Besides, all financial institutions sell products as “sellers”, so it is hard to carry out systematic management of the demands of clients.
Compared with trusts and financial products, they boast an infinite capacity, and family trust structures with demand-based flexible combinations have significant advantages. To make plans for a customized family trust based on well-structured thinking, one should take into account factors like the establishment objectives of the client, the specific situations of the family, requirements for allocation, and the balance of benefits between trust-related parties. Based on the integration of all clients’ demands, different types of assets – such as real estate, stocks, equities, insurance and cash – are placed in the family trust structure in a logical manner, thus creating good synergy. The family trust architecture expands the capacity of assets and creates greater potential for extension and flexibility. And, most importantly, clients’ demands are satisfied all round.
High-quality family trust structures can also result in other positive effects. For example, reasonable insurance planning can be introduced into the family trust structure. Through such insurance, the time values of the family members of each generation will be realized and returned to the family trust structure for the allocation of expenditure for the next generation. These close ties to capital lay a firm foundation for the long-term operation of family trusts. From the perspective of a service provider, it not only facilitates a long-term stable relationship among family members from different generations, but also offers more customized services.
- Logic-based, refined planning and accurate services
An outstanding family wealth planner can offer high-end clients individualized services – not as products or institutions – as a unique experience. He or she can clarify the logical planning of family trusts at all levels and then develop refined strategies for different types of assets. This is also the core of their competitiveness. After all, tools are inflexible. Only by following a logical system can tools be effectively implemented. This shall be briefly illustrated below.
- Asset class: stocks
- Logic to follow: lead future cash flow directly to other areas to defer taxes and to reasonably avoid taxes.
What bothers many listed companies the most is paying income taxes on dividends every year. Major shareholders have to pay income taxes after having obtained dividends. According to my years of experience in the service industry, many high net-worth clients don’t need to use these yearly dividends, and even plan to accumulate them for descendants.
We have to be careful that, if a gift tax is introduced in the future, this tax may be at a rate as high as 40-50%, which could be deducted when such dividends are passed on to the next generation. So only half the value would actually be delivered, at most. Therefore, to prevent such a risk, it would be wise to funnel such dividends directly into a family trust and then distribute them to the next generation after a certain period of time. This will not only deter individual income tax, but also decrease the tax base, thus reasonably saving taxes. Of course, family trusts are not established to avoid taxes, but to reasonably save taxes through sound trust structures.
Theoretically, placing assets within a family trust structure will create certain costs. However, depending on the timing of placements, the costs may vary greatly. At present, assets are mostly transferred from a client to a trustee via gifts or sales agreements. With neither inheritance tax nor gift tax introduced, the client only needs to pay a small proportion in commission. If their assets increase in value rapidly before they are placed into trusts in the future, it may mean the asset base is enlarged. Besides an increase in commission, the client may also face the risk of high inheritance tax or gift tax, which makes it even worse. Therefore, seen from the perspective of long-term planning, the cost of prevention is much lower than the cost of asset management later.
- Reach a consensus based on quantified data and repeated calculations
During initial communication about the expectations of a family trust, most clients express their demands based on individual preferences and priorities. For example, to encourage the education and development of talented family members (in the context of family trusts) how much should be awarded from the trust to descendants who pass entrance examinations at the top 50 universities in the world? Clients can only propose an approximate figure at the very beginning, such as 200,000 or 300,000. If such a trust aims to cover the future five generations, what is the estimated increase in family members (according to the fertility coefficient of each generation)? If all new members pass such examinations, and inflation is a considered factor, how much should be invested at present? How much cash will be generated each year to compensate such awards? Clients have no real idea about such significant problems. Therefore, personal thoughts or feelings must be turned into rational data to enable clients to understand the expected functions of a family trust and to reasonably measure the current investment scale and portfolio planning necessary.
Panhe Family Office has set up an exclusive Family Trust Career Cash Flow Statement for clients, which simulates the amount of asset input required to ensure sufficient cash inflow for trust structures to cover future expenditure based on a rigorous actuarial model, according to the objectives and the appeal of family trusts.
The most direct quantification of the personal demands of the family trust is “how many people do you want to prepare funds for?” Starting from such a demand, the corresponding consideration within the Family Trust Career Cash Flow Statement is “how much money is needed to solve how many demands of how many people?” Taking this as a logical thread for family trusts, family trust cash flow management and control systems with dynamic adjustment functions are established. Panhe Family Office makes exclusive cash flow statements for each family trust client, so the status of each family is unique.
Based on the assessment of external environment factors and internal family factors, the cash flow statement incorporates variable elements such as inflation rate, discount rate, gap between generations, and life expectancy. Using different portfolios and different variable inputs, the internal rate of return (IRR) of the cash flow system for different combinations is calculated. If the functional expenditure on certain aspects is too much or too little, clients may also use this statement to calculate and request suggestions from a professional team to understand how to reach a balance.
Family trusts are mainly set up to take care of descendants and to ensure the sustainability of a family, so they emphasize stability rather than risky increases in value. With the help of the professional team at Panhe Family Office, clients may use this exclusive Family Trust Career Cash Flow Statement to make multi-dimensional estimations and calculations by inputting different parameters, striving to reach a consensus on risk preference, existing investment ability and future bearing capacity, and eventually to discover optimal planning for family trust structures based on these comprehensive considerations. These family trusts are what clients are longing for the most.
- Systematic management, regular reviews and reasonable adjustment
Family trusts that are set up to benefit a family’s future generations cannot be operated as independent projects. Instead, they should be followed up as a systematic project closely linked to the family’s development, and be monitored, evaluated and improved on a regular basis. To set up a family trust is a good start, but whether it may be fully implemented to achieve positive effects depends on long-term management and maintenance.
The family is an ecological system undergoing long-term development and changes, such as an increase of family members, changes in marriage, adjustments in tax and nationality, as well as external changes in market environment and economic policies. Therefore, a project team has to be set up to manage, regulate and control it in the long term. Abiding by such a philosophy, Panhe Family Office carries out systematic reviews of clients’ family trusts on a regular basis, integrates the investment statements of several financial institutions, provides clients with overall analysis reports, oversees whether major financial institutions operate according to the agreed structure, makes reasonable adjustments according to clients’ wishes and the demands of relevant family members, and strives to ensure the long-term sound operation of family trusts in accordance with clients’ intentions.
Besides regular monthly reviews and annual reviews, Panhe Family Office also sets up emergency reviews and coping mechanisms. For example, in case of large-scale black swan events like Brexit, a professional planning team will offer clients suggestions on adjustments according to the level of asset risk and future trends, and make great efforts to create a family trust engineering system with both strong anti-risk capabilities and flexibility to comply with potential developments and changes in the future, so as to maintain the sustainable development of a family.
By Andrew Yen