Family business owners often make certain assumptions — that their children will gladly succeed them or that they’ll be able to transfer ownership and enjoy a comfortable retirement. Such assumptions can be dangerous. For starters, family members may have other career objectives. Even if they don’t, succession planning can be tricky, involving both your retirement and estate plans.

Naming a Successor

Your first planning priority is to name a successor. If a child is active in the business and capable of taking over, confirm that he or she is interested. Then begin the grooming process. If, on the other hand, several family members are jockeying for the position, you may need to make some difficult decisions. Once you do, let everyone know your intentions well in advance of retirement. Good communication is critical to avoiding conflict.

Often, business owners don’t know how they’ll eventually divide their wealth among heirs who are active in the business and those who are not. If you have significant nonbusiness assets such as real estate or a stock portfolio, you might make an equitable division by leaving those to the nonactive heirs. But if the bulk of your wealth is tied up in your business, you might give voting stock to the active heirs and nonvoting stock to the others.

Transferring Ownership

Next consider how you’ll ransfer ownership and retire comfortably. You might pass on management, but retain ownership and financial control. Or, your successor might buy the business outright. Unfortunately, family business successors rarely have the cash to do so. Therefore, you might want to place the business in a trust.

A grantor retained annuity trust (GRAT) can provide you with income for a term of years and then distribute the remaining assets to your beneficiaries. Such trusts offer compelling tax advantages. When you transfer your ownership interests into the GRAT, it’s considered a taxable gift. But the annuity you receive reduces the value of that gift. Plus, future appreciation can be removed from your taxable estate.

Note one drawback: If you die before the end of the annuity period, the trust assets will be included in your estate, effectively eliminating the GRAT’s estate tax benefits.

Other potential business transfer vehicles

  • Employee stock ownership plans (ESOPs). An ESOP is a qualified retirement plan that’s required to invest primarily in the company’s stock. It can be a tax-efficient means of transferring stock to family members and removing some equity from the business for retirement income.
  • Self-canceling installment notes (SCINs). A SCIN terminates a successor’s purchase payment obligations on your death without adverse tax consequences. This strategy can be risky, but if you have reason to believe that you won’t reach your actuarial life expectancy, a SCIN can provide your family with a tax-free windfall.
  • Other financing alternatives. These include a family limited partnership, financing the sale yourself, seeking private investment capital or even going public. Such strategies are complicated, and professional advice is essential to execute them.

Don’t Wait Until It’s Too Late

Family and retirement income considerations are only a few of the myriad issues involved in transferring a family business to the next generation. The sooner you start planning, the better.