The last 30 years have revealed deficiencies in traditional estate planning. A huge transfer of wealth from the greatest generation to baby boomers was predicted; much less was actually transferred.
There is significant research about the discrepancy between the expectations of the boomers and the amount they ultimately inherited. Where did the wealth go, and why was the wealth transfer inefficient?
The primary reasons for the inefficiency include increased longevity; investment risks; long-term care expenses; failure to plan early; inappropriate design of transfers; and a failure to engage and prepare inheritors. The lessons learned from the past mean the next generation of inheritors stand to benefit from improved efficiency.
Now, boomers have significant wealth to transfer. Advisers and clients need to focus on preparing territories and the forms of wealth transfer. A client cannot begin early enough to pass along a sense of responsibility and discipline for handling wealth.
Start teaching young children basic budgeting. Provide those children with a vacation allowance, and challenge them to make it last for the entire trip. For older children, make a gift of the maximum amount a child can contribute to a Roth IRA.
Mentoring involves permitting heirs to invest limited funds while observing their money management skills. Heirs should not just start learning about wealth management upon inheriting a major sum. It is important to demand a work ethic and achievement, and avoid enabling a child to become a professional beneficiary. Many high-net-worth individuals destroy the work ethic and incentive of heirs by providing too much too soon without demanding accountability.
Having a cohesive plan is critically important. The wealth manager working with the client should explain the mechanisms and implications of wealth transfer.
Knowledge needs to include the form of inheritance as well as its impact. For example, one should never make significant outright transfers to minors or beneficiaries below a level of adult maturity to handle disciplined wealth management. There are additional challenges in making provisions for blended families.
Conducting a beneficiary designation audit is an important step. A will only transfers assets in probate that include assets owned individually by the decedent without a beneficiary designation. Wealth vehicles like life insurance, annuities, retirement plans, IRAs and transfer on death agreements transfer the associated wealth by beneficiary designation. Accounts titled jointly with rights of survivorship automatically pass outright to the joint tenant(s) at the client's death. There must be a significant discussion about estate transfers with the attorney drafting the will. A plan will unravel if the client and other advisers create wealth transfer mechanisms that do not follow the will's specifications.
A trust is an ingenious way of handling specific personal and tax-planning objectives. It is a private contract created by the grantor that transfers the wealth and is administered by a fiduciary who must act in the best interest of the beneficiaries.
Trusts can provide protection for beneficiaries, and instructions to incentivize and prepare beneficiaries to manage wealth. However, a trust is complex. The focus should be more about appropriate distribution planning for beneficiaries and less about tax planning.
Psychologists dealing with family wealth management would never recommend keeping beneficiaries uninformed. It is better to prepare and mentor them to manage wealth. This should include planning for the long-term care challenges of individuals who would otherwise transfer more wealth.
The wealth manager should suggest multigenerational family meetings to educate and inform heirs of their responsibility to manage the senior generation's late-stage expenses and to manage the family wealth that they inherit in a responsible, disciplined manner.
Ted Kurlowicz is a professor of taxation at The American College.