“A very rich person should leave his kids enough to do anything but not enough to do nothing.”
—Warren Buffett
• An 85-year-old former university professor told us that he wanted his will to include a gift to his university. “Why wait?” we asked after reviewing his situation. We designed a structure that allowed him to make the donation and have the pleasure of seeing a chair named after him.
• A client owned a piece of historic designated real estate that she wanted to pass on to her family. She did not have the liquidity to just give it to her children, as she needed the tax benefits and a place to sleep, but she was willing to live with reduced benefits as time went by. She transferred the house to an LLC and every year she gifted a share of the LLC to a trust equal to the gift exclusion to her children. However, she got to live in the house and ensure her historic residence stays in the family.
• Another client had established a trust for her son. There was a clause in her will—a power of appointment—that allowed her husband to redirect a portion of their assets. Her intent was to make sure her husband would have financial options—especially the ability to donate to charity. After her death and his remarriage, he exercised the clause—but not for charitable reasons. Instead, he was determined to make null and void the intent of her entire will. He transferred the trust—which carried his son’s name—and all his other remaining assets to his second wife’s children. His own children were left without the trust or any of his assets in their name.
As these cases illustrate, creating a legacy is a challenging goal. This is especially true for high-net-worth individuals because of the size of their assets and the complexity of the vehicles they typically use to pass wealth to the next generation. The combination of money, emotion, family history and unresolved issues can be a volatile mix that brings out the worst in everyone. On the other hand, it can be a tool for sound lessons and wise decisions that strengthen family bonds.
Properly planning a client’s legacy requires attention, forethought and good advice—about financial and tax strategies, certainly, but also about the psychological and emotional impact of the decisions made. Should you transfer the bulk of your wealth while you are still alive? What structures and vehicles will you use? What lessons will your children learn—and are they the lessons you want them to learn?
Such questions are increasingly prevalent and increasingly urgent because we are in the midst of one of the greatest wealth transfers in history. The transfer of wealth in the U.S. from 1998 to 2052 will amount to at least $41 trillion and could be as high as $136 trillion, according to a study by the Boston College Social Welfare Research Institute. This will have a huge effect on not only high-net-worth families, but also on society as a whole.
Many people would rather just put these questions aside and defer any decisions. But the cost of inaction or taking too narrow a view on estate planning can be high. Some clients may only wish to focus on minimizing taxes, but it is far more important to have an overall plan. Clients need to know their financial picture, know their children and know what they want to accomplish. Only when they’ve taken a broad view and established their goals can you design an appropriate plan.
The emotional side of wealth transfers
Once you get past dealing with your own mortality, what makes the topic of legacies so difficult to discuss? Obviously, generational wealth transfers are not just financial transactions. Transferring wealth raises complex psychological and interpersonal issues that involve life goals and how children relate to them; the value of work versus the benefits of financial security; and long family histories that mix love, fierce conflict, expectations, ambitions, resentment, rebellion and respect.
On a more mundane and practical level, transferring wealth to the next generation can create real risk. Inheriting a great deal of money can lead the uninitiated or inexperienced into dangerous behaviors. There is no shortage of cautionary tales: unprepared children who go on spending sprees and who make bad life decisions, such as dropping out of school, quitting jobs and falling into a variety of addictions. They might lose their drive for success, give up on their ambitions and accomplish less than they would have if their wealth had not been guaranteed.
Alternatives to sudden wealth transfer
To avoid such outcomes, many high-net-worth individuals are looking for alternative ways to transfer wealth to their children. Warren Buffett’s quote at the beginning of this article illustrates this outlook. Facebook founder Mark Zuckerberg and his wife, Priscilla Chan, recently announced in an open letter to their newborn daughter that they will donate 99% of their Facebook holdings, valued at $45 billion, during their lifetime to create the Chan Zuckerberg Initiative, which will seek to “leave the world a better place for you and all children.”
Only half of millionaire baby boomers think it’s important to leave money to their children, according to a recent U.S. Trust survey. A third of them said they would rather leave money to charity. In fact, U.S. Trust found that only 32 percent of baby boomers are confident their children will be prepared emotionally and financially to receive a financial legacy.
Boomers’ skepticism about large inheritances was also the subject of a recent CNBC article, which reported that boomers want their children to learn about struggle, hard work, failure and the joys of earned success—lessons they believe helped them become more successful. They also had doubts about their children’s ability to handle large sums of money.
If clients share these concerns, what are their options? Are there alternatives to a large, lump-sum inheritance that are worth considering?
The first step is to think through their concerns about creating an inheritance—not in the abstract, as we’ve done above, but in terms of the clients, their children and the issues that they face. That means thinking about how they as individuals would react to sudden wealth. Would it be an opportunity for the children to prosper? Or would it open the door to dangerous outcomes?
The second step is to realize that there are many alternatives to a traditional legacy. As clients review their challenges, some of these alternatives will naturally suggest themselves:
• Are there relationship issues? For example, is the family contending with divorces and other social conflicts with friends, ex-wives, the current spouse or in-laws that might result in future problems? The structure of the legacy should take these into account.
• Are the children burdened by huge student loans? Before you even begin to think about a legacy, you might consider clearing up this debt. College loans are usually expensive, and repayment comes due just as the children are first getting their start in life. A gift of debt relief can be truly meaningful. A parent can use the need for reduction of educational debt as an excuse to delay other gifts until the children mature.
• Do the children or grandchildren have a 529 plan? Think about contributing to this as part of a legacy plan. Contributions within the gift tax annual exclusion amount are generally free of both the gift tax and the generation-skipping transfer tax. Qualifying distributions for educational expenses are income-tax-free to the designated beneficiary.
• Could you pay for children’s or grandchildren’s tuitions directly to the university, since these are not considered taxable gifts?
• Can medical issues for a child or grandchild cause a financial hardship? Consider setting up a special needs trust to ensure proper attention is paid to the child when the client can’t.
• Does a child have a drug or gambling problem or other destructive addictions? Consider a trust. In every large lump-sum inheritance, there is the possibility that children may never do another day’s work and spend it all on vices or fast living. If there is already a known risk, why increase the odds of their falling prey to it? A well-managed trust and a good trustee can keep that from happening.
These are just a few examples. But they illustrate the kind of thinking you’ll want to do in planning how to pass on a client’s wealth. The point is to take into account the full reality of a family’s situation and think through every option. Clients need to know that they do not need to feel compelled to commit to a onetime, lump-sum wealth transfer. There may be powerful arguments against giving too much, too soon.
The planning process must address more than just family issues, of course. There are financial and tax strategies to consider as well. A thorough review will encompass financial planning; tax and legal issues; as well as a client’s goals, hopes, dreams and family realities.
Robert G. Kuchner, CPA/PFS, is a partner at the accouting firm Marks Paneth LLP, which is based in New York City.
