The creators of family wealth may want the money they have worked so hard to accumulate to last forever, but more often than not, the wealth disappears by the third generation.
It’s one of the most vexing problems financial advisors have to deal with when serving wealthy families. Those experienced in this market, however, have developed a variety of strategies to preserve assets for the third generation and beyond.
“Most families don’t make the grade when it comes to preserving wealth across generations,” Stacy Allred, managing director and wealth strategist for the Merrill Lynch Private Banking and Investment Group, wrote in a recent study. “This unfortunate reality can so often be avoided by understanding pitfalls and developing a strategy.”
The recent Merrill Lynch study showed 69% of Americans with at least $5 million in investable assets want their money to last through their children’s generation and 43% want it to last through their grandchildren’s lives. Seventeen percent want the money to last forever.
But in more than two out of three cases, family wealth fails to outlive the generation following the one that created it, and 90% of the time the assets are exhausted before the end of the third generation, according to the report by Merrill Lynch’s Private Banking and Investment Group.
“Determining the purpose of your wealth, including how long you’d like it to last, is a critical first step,” Allred says. “With these insights, you can establish certain safeguards and back into a spending rate that may not deplete the family assets.”
Advisors to high-net-worth clients attack the problem in various ways; they say one of the keys is good communication between the parents and their children.
“You always hear about the shirtsleeves to shirtsleeves phenomenon where the money is gone by the third generation, but we are hopeful that early communication helps families become more successful,” says Donna Trammell, director of family wealth stewardship at Bessemer Trust in New York City. “The problem arises when there is a lack of preparation of the next generation.”
Bessemer uses peer groups for wealth creators and heirs. “Millennials are a phenomenal generation. They value communication and appreciate context,” she says.
One objective of the meetings is to encourage wealth creators to communicate the family history and philosophy to their heirs.
“It is never too early to start building a foundation for heirs. Parents need to give their children incremental responsibility so they can make mistakes before the stakes get too high,” Trammell says.
Allred noted in the study that many families establish a statement of values that describes the impact they want their wealth to have on themselves, their families and their community. “Being intentional about this process leaves them poised to make better decisions,” she said.
When asked when wealth should be transferred, 74% of respondents to the Merrill Lynch study said it should be when children reach a milestone, such as graduating, starting a career or getting married. Seventy-three percent also said the money should be given for a specific purpose, such as paying for college or buying a first home.
Giving Too Much
Clients who give too much to their children are a common problem in the financial industry, according to Coventry Edwards-Pitt, an advisor at Ballentine Partners, a multifamily office in Waltham, Mass., and author of Raised Healthy, Wealthy, & Wise—Lessons from Successful and Grounded Inheritors and How They Got That Way.
“Some clients are focused on giving money to children when they reach a certain age, but they should be focused on whether the child has the key factors for success,” she says. “The children should demonstrate they can earn their own money and live off of it. They should be able to set their own professional goals and not have their self worth wrapped up in the family’s wealth.”
That means setting limits and imposing rules on the children, which is often difficult for the parents. “Most of the industry is focused on how the children can handle the parents’ money, but no child feels successful in his own right until he has lived on his own,” she says.
John Waldron of Waldron Wealth Management in Pittsburgh agrees that establishing a sense of responsibility in heirs is vital. “Many have little or no self confidence,” he says. “A lot of stuff that normal people do has been done for them.”
Waldron holds regular family meetings that include the heirs at some point, often when they go to college or when they graduate.
“Families have to have open and honest communication about where the money came from and what it means to the family,” he says.
The Merrill Lynch report indicated there is a disconnect between what people say they believe and what they do when trying to pass on their financial values. Sixty-eight percent of the respondents said discussions about a family’s wealth should begin before an heir’s 18th birthday, but only 45% actually have the discussions that early. Only 29% said families should wait to have these conversations starting at the age of 18, yet that’s when 48% actually do it.
Open Discussions
“Parents avoid discussions about the extent of their family’s wealth with their children in fear of dulling their ambitions or creating a sense of entitlement,” says Michael Liersch, head of behavioral finance for Merrill Lynch, commenting in a press release about the reports. “While important to reveal such sensitive information in the right way and at the right time, outright resistance may be viewed by the next generation as a sign of distrust or lack of faith in their judgment, which can lead to a lapse or collapse in communication.”
Communication is considered so important at Charles D. Haines LLC in Birmingham, Ala., that the firm holds family meetings on talking and listening techniques. “Effective communication is key in any relationship,” says firm founder Charles D. Haines.
But Haines notes that the meeting room can only go so far in solidifying a family relationship, and that actions are just as important.
“Children learn as much from what you do as what you say,” he says. “If the parents are not modeling the values they are trying to transfer to their children, it is not going to happen.”
It’s also important for advisors not to make any assumptions about clients’ attitudes about wealth transfers. For example, not all families want their children to inherit the wealth, says Domenic DiPiero, president of Newport Capital Group in Red Bank, N.J. “The first question you have to ask a client is do they want the money to last,” he says. “Some want to give it to charity.”
For those who want to pass on their wealth, DiPiero can speak from personal experience. He and his brother hold second-generation wealth and they both have their own successful careers.
To help the clients create a sense of self-worth in the potential heirs, Newport Capital hires clients’ children as interns.
“More and more wealthy people want their children to be productive. It could be in any career,” DiPiero says. “Just giving the money to the heirs unencumbered is not in favor now. Families want to make sure their money does good. For heirs to succeed, they need to know how the family got the money and how easy it is to lose it.”
Many people have unrealistic notions about what constitutes a sustainable spending strategy that preserves their wealth for several generations, according to the Merrill Lynch study. Thirty-nine percent believe a portfolio can last forever with an annual distribution rate of 6% or more, while another 20% have no idea what an appropriate distribution rate is.
In reality, Merrill Lynch says, data suggests that even for the wealthiest families, wealth sustainability may require an average distribution rate as low as 2% per year, a fact understood by only 16% of those surveyed.
