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Many of the affluent investors that we work with at Cape May have reached one of the biggest milestones of an individual’s life. Not selling their business, not reaching a certain net worth, but rather, a personal one: they have become a parent.

While the first years of family life often are focused on personal matters, most parents also start to think about the financial implications. That starts at simple questions such as how having a child affects their financial situation today, or how much money they should put aside for their education. But sooner or later, most affluent individuals find themselves thinking about the long-term financial implications of their wealth - and how their children (and wider family) should benefit from it.

Interestingly, the challenges related to these questions are less of a ‘technical’ nature. While German tax and corporate law can be complex, topics such as gifting cash or assets to your children are for the most part actually not so complicated. Rather, the challenge tends to be a more psychological one: wealth owners have to think about questions such as when the transfer should take place, what it should encompass, and what their involvement should look like. And as with many questions in life, there is no right or wrong - but just a set of answers right for the wealth owner(s) and their family.

Today, let us give you an overview of the most important questions a wealth owner should ask themselves in context of their succession planning. Our overview is influenced both by our presence (and that of most of our clients) in Germany, as well as their typically modest degree of complexity in their wealth. If you are not based in Germany, or if your situation involves multi-generational operating businesses and/or a substantial number of jurisdictions, this article might be more of a starting point rather than a complete roadmap. Either way, we hope it can be a good starting point for you - and of course, reach out to Tamara and me for a more tailored conversation.

Once you’ve decided to pass on your wealth, the first question, typically, is how much - and in what form. There are a few things to consider:

First of all - do you want to pass on all of your wealth to your children, or do you have other plans? You might want to pass on most of your assets to your children with a ‘carve-out’ for charitable giving. Maybe you have a family business that shouldn’t go to your children, but rather to a (charitable) foundation (or maybe even a person outside the family). Or maybe you would rather see your children build their own fortune from scratch. (528491…)

Do you want to split your wealth equally amongst your children? In most cases, the parents want all their children to benefit equally from the family wealth - but the exact implementation might look different. Maybe your wealth should first go to your spouse and your children. But even when it reaches their scope, is it really a “clean split”? Maybe one child receives the family business while the others are paid out? Maybe your fortune is split cleanly on a market value basis, but the underlying assets are divided up according to your (and your children’s) preferences?

And of course there are questions such as where and how, and of course, when to make those transfers.

Transferring wealth to your children can happen in multiple ways, all with specific pros and cons to them.

First, a direct gift of an asset to your child. That could be as simple as gifting them cash or liquid equivalents (i.e. stocks, bonds, ETFs), but could also be a gift of an illiquid asset, like a personal residence or a rental property. Here in Germany, such a transfer is fairly straightforward (assuming that a fair market value can be found, esp. for illiquid assets). However, for better and for worse, your children become direct owners of whatever you gift them. Assuming the ‘worst case’ outlined in our prior section on the when, they could take the 400.000€ you gifted them (the Freibetrag, i.e. the amount transferable to your child every ten years without incurring gift taxes) and spend it on cars, champagne, and dubious companions.

Secondly, gifting them shares in a (holding) company. Assume, for example, that you have a holding company holding liquid assets valued at 4.000.000€. Rather than distributing this cash to your private level (and incurring taxes in doing so), you could instead gift shares in that holding company to your child. Once again using the 400.000€ Freibetrag, you could gift them 10% of your shares in the holding company.

Transferring shares in a holding company has a number of benefits. First, your children don’t become direct beneficiaries to the cash and can spend it, leaving you (or a trusted party) in control of the assets and any distributions. (If you really want to optimize for control,  you could gift your children a substantial wealth in the form of shares in a holding company but still control entirely if and when they benefit from this.) Secondly, family companies allow for a more practical transfer of complex fortunes. For example, if you don’t just have cash but a portfolio of assets ranging from liquid stock to illiquid fund and direct investments, you can transfer a share in all these assets through a holding company rather than having to transfer a small share in each asset.

However, such structures bring heightened complexity. If you want to do everything right, you need to be very clear on what the rules of the holding company should be, covering aspects such as control, voting rights, a right of an individual to ‘leave’ the holding company (if, when, and at what price), and many other factors as well. Also note any ongoing obligations, such as accounting, tax returns, and/or disclosure requirements.

Third, family foundations. Rather than transferring the family assets to an individual directly (i.e. as a gift) or indirectly (through a holding company), the family member becomes a “beneficiary”, entitling to some form of benefit, i.e. a regular payment from the foundation without ceding any control of how the assets are invested. Typically, we see family foundations set up in a way where the “principal” (i.e. the initial investment to set up the foundation) can never be distributed, thus only allowing proceeds from investment gains on this principal (after fees, taxes, and often an inflation adjustment) to be distributed to the family members. While they can sometimes have tax benefits (i.e. no or little tax at foundation level), they can be very inflexible, with many families worrying about losing control. Accordingly, there has only been a small number of cases among our clients where Tamara and I actually were in favor of choosing a foundation over more flexible structures, such as a family holding company.)

Fourth and last, your own family office. For our typical client with 2-25M€ in investable assets, setting up their own family office is typically a less relevant option - but as many of our readers are family officers, we wanted to be comprehensive. In the context of a wealth transfer, we see family offices either as the party in formal control of the holding company and its investments, and/or as an asset manager offering managed accounts (Vermögensverwaltung) or a private fund structure that family members can invest in and redeem from as they prefer. (For continued reading, check out Family Office 101, The future of the family office, and The Case for Small Family Offices.)

In regards to the ‘when’, we typically see a few considerations at play for the family.

First, when the children should become beneficiaries to the family wealth. In Germany, passing on wealth earlier rather than later can make sense as the tax exemptions (Freibeträge) reset every ten years. Accordingly, if optimizing solely for early transfer in order to save expected gift/inheritance tax, parents might opt towards transferring money as soon as they can.

However, if done as a simple (cash/stock) gift to the child without any sort of control measures, the child receives full legal control over those funds by the time they reach legal age (i.e. 18). Despite the potential tax benefits, many parents are concerned that legal age might not mean that the child has reached emotional maturity, and might spend their wealth in imprudent ways. Accordingly, some parents opt for control measures (more on that below), or simply wait longer to gift substantial sums, even if that is detrimental from a tax optimization standpoint. (Practically, we see first five- to six-figure gifts around legal age, with more substantial gifts transferred around a child’s 30th birthday, when most parents expect them to have reached emotional maturity.)

Secondly, when you want to pass on the wealth. This is most relevant in the case of operating companies, but of course also a concern for investment-focused structures like a holding company or a family office. As real-life stories like that of James Murdoch’s family empire, or TV shows like Succession have shown us, parents and children might not always be in agreement when the older generation should pass on leadership and/or assets to the next generation. Personal preferences differ greatly, but we typically see parents passing on wealth sooner rather than later, although with a level of retained control (i.e. in case the child marries someone they might not fully agree with).

You’ve thought about what assets you want to transfer to your children. You’ve made a plan when that transfer should take place. And you’ve also thought about where that wealth should be managed. So let’s get to the final question: how do they actually receive the assets?

In Germany, the most common way to transfer assets is a gift (Schenkung), meaning you, the private individual and owner of your wealth, transfer certain assets from your private control, free of charge, to your children. Doing so is subject to the aforementioned Freibetrag (i.e. gift tax exemption) of up to 400.000€ every 10 years. Gifting more than this can trigger gift taxes, which can range from 7% to up to 30%. There are certain factors which might positively influence how assets are valued, especially in the case of operating companies, which might reduce the value of your assets from a gift tax perspective, thus lowering your effective tax burden. (If you want to learn more about that, reach out to my colleague Tamara). 

Especially for large fortunes, chances are that you have a substantially larger asset base than the gift tax exemption can cover, again reinforcing our prior statement that you should start thinking about your wealth transfer earlier than later. As touched upon earlier, gifting is also not limited to liquid assets but can also be done in the form of shares in an operating or holding company.

So rather than gifting assets, you could also sell those assets to your children. But how do they pay for those assets, especially in the case of a larger fortune?

Besides using the cash that you gifted to them earlier, you could also provide them with a loan. Such loans can be structured in many ways, ranging from outright loans to your children to build wealth, to loans in the context of specific asset sales (i.e. a seller note where you as the seller effectively lend the money to your child with which they buy the asset), to associated options such as loan guarantees. Loans can be a very effective tool, but always need to be done at arm’s length, i.e. market-rate terms as if providing the same loan to a third party that does not have the benefit of being a family member of yours.

Lastly, we want to highlight a variation that we often see utilized in the context of complex family fortunes: A so called life interest (sometimes also called usufruct, or in German, a Nießbrauchsrecht). A life interest effectively allows you to transfer the ownership in an asset to another party (whether it’s your children, your partner, or a third party), while retaining certain benefits of said assets. For example, if transferring your personal residence, your Nießbrauch might be a right of residence (Wohnrecht) until the end of your life. In the case of a rental property or even an operating company, you might retain a right to receive the asset’s cash flows until your passing.

Unsurprisingly, granting such rights typically reduces the value that a buyer would want to pay for such an asset today. But in the context of wealth transfer, that can be a powerful lever: the German financial authorities typically accept a reduction in value created by a Nießbrauch, effectively reducing the market value of assets, and thus, the gift tax payable when transferring those assets to your children. And it can ensure that you still retain cashflows from your family fortune, letting you sleep at night even in the latter years of your life. (One recent “back of the envelope” calculation for a life interest on a client’s liquid asset portfolio, held through a GmbH, indicated a potential value reduction for gift tax purposes of over 60% (!) - not something you should sleep on. Once again, if you want to learn more, Tamara is the person you should talk to.)

Let’s make all of this more concrete with a recent client example.

Our client was in their late 50s and had successfully sold their business a few years ago for a mid-seven figure amount. While our analysis had shown that they’d likely need their assets and the expected long-term gains to sustain their lifestyle into their retirement, they also wanted to kick off the wealth transfer to their two children (both in their early- to mid-twenties). While they, like many of our clients, were worried of the potentially ‘corrupting’ influence of passing on substantial sums of money, they and their partner agreed that they wanted their children to benefit from their hard-earned wealth rather sooner than later. Nevertheless, they wanted to have control rights in place, especially to ensure they could continue drawing on the portfolio to fund their lifestyle.

After discussing the matter with Tamara and me, we eventually settled on a family holding company in the form of a limited partnership (GmbH & Co. KG). For their wealth, which was primarily allocated to liquid investments and real estate, we saw no need for a non-transparent structure such as a GmbH. Compared to direct gifts to their children, a partnership structure also allowed more room to implement the desired control measures, albeit with a slight level of complexity, i.e. in the form of ongoing accounting and filing requirements.

Furthermore, we complemented this structure with a life interest (Nießbrauch) on the shares gifted to their children. Doing so brought two key benefits: One, it reflected the client’s desire to transfer most of their wealth to their children while still ensuring that any cashflows generated from their wealth would be available for their lifestyle. (After the 10-year period, they could also use excess cash at their level for further gifts to their children.) Two, it lowered the value of their assets (for gift tax purposes) substantially, bringing it close to the aforementioned 400.000€ in exemption and thus incurring only marginal gift tax today.

Getting there, of course, was not as simple as three paragraphs in a newsletter make it seem. Our discussions took place over many months, with even more discussion between our client, their partner, and their children in the background. Which once again reinforces our point from the introduction: setting up a family holding company or comparable structure, at least from a legal and tax perspective, is typically not so difficult - rather, it’s the question what you, the wealth owner, and your family want to achieve commercially and emotionally.

Lastly, don’t feel forced to make binary choices. We often see affluent investors struggle because they want to find the ‘one’ structure that can perfectly address their individual needs. Sometimes, such a structure exists (as in the case of our client) - but more often, it is rather a combination of structures and approaches that can be ideal. Think different blocks for the where (some assets gifted to your children directly, some through a family holding company), for the when (some today, some over time, some at your passing), and for the how (combining gifts, loans, and the Nießbrauch).

Direct gifts? A holding company? Or even a family foundation?

If you’d like to think through what the right structure can look like for you and your family, reach out - it’s exactly the kind of question that we address for our clients on a regular basis. Tamara and I would be happy to help.