Steps to take and mistakes to avoid
There’s a reason why 70% of wealthy families lose a majority of their wealth before the end of the second generation and 90% tend to lose it all before the end of the third generation. The truth is, most inheritors of wealth receive very little financial insight or guidance from the previous generations, and so they endeavor to manage their newfound wealth on their own. It’s much like getting behind the wheel of a Ferrari without ever having a driving lesson – rarely is the outcome going to be positive.
Because you work with a trusted advisor, however, your likelihood of success will increase exponentially. Families that are able to sustain wealth across multiple generations tend to exhibit key commonalities – from shared values and open, honest communication, to a passion for financial learning and a commitment to thoughtful planning. Perhaps most importantly, however, they rely on the trusted counsel of professional advisors to help guide them on their wealth journey.
Drivers of Success
While each individual’s particular circumstances, short-term needs, and long-term goals will be unique, the following are just a few best practices that can dramatically improve your chances of not just sustaining but enhancing the wealth you inherit:
- Think before you act: don’t fall into the common trap of recounting all the luxuries you’ve denied yourself in order to save, and looking on a windfall or inheritance as an opportunity to overindulge. Certainly there’s nothing wrong with setting aside a little money to splurge with; but if you binge spend now, odds are you’ll come up short of reaching your long-range goals. Consider parking your inheritance in a low-risk liquid account while you talk with your advisor and explore your various investment options.
- Retirement first: as humans, we are hard-wired to focus more on short-term needs rather than long-term objectives. Whether it’s buying a bigger house or sending our kids to private school, your immediate concerns often just seem far more pressing than something many years down the road like retirement. When you receive a windfall, however, try to think in reverse – from the furthest away to the closest. Ideally, you should allocate the lion’s share of your inheritance to your retirement savings; then move to mid-range goals such as putting money into a 529 Plan account for your children’s education; and finally address your shorter-term needs. It may seem counterintuitive, but by addressing long-term needs first, you may be able to free up more of your regular income to handle day-to-day financial needs.
- Pay off high-interest debt: the one area where short-term needs should override long-term goals is in regards to any high-interest debt you may have. Prior to putting money away for retirement or making lifestyle purchases, pay down any credit card and personal loan debt you may be carrying.
- Don’t overlook tax obligations: with the federal estate tax exemption at $11.2 million per individual, federal taxes are no longer a concern for the vast majority of estates. It’s important to note, however, that a number of states including Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania impose state-mandated inheritance taxes that range in severity from 1% to 18%.
While most inherited assets are relatively simple and straight-forward, you may receive assets that are held in trust or assets where you’ll need to make certain distribution decisions.
Assets Held in Trust
Oftentimes, parents turn to trusts not as a way to micromanage their children’s inheritances, but as a means of ensuring that those assets are protected from potential creditors or a future divorce. When assets are in trust, the inheritance will be managed by a trustee (usually an investment advisor, banker, lawyer, or other family member) who is responsible for overseeing the investment and distribution of assets according to the trust’s language. As a beneficiary, you’ll want to carefully read the trust documents so that you understand the trustee’s duties and obligations. Also, you will want to make certain that you receive regular updates on the trust’s investments, distributions, and performance.
If you’re the named beneficiary on one or more IRAs (except for Roth IRAs which are generally tax-free) you will have a decision to make about how and when you will begin to take distributions. Some factors that impact your options will be beyond your control, such as your relationship to the original account owner, if he or she had already begun to take required minimum distributions (RMDs) from the account, and whether there are multiple account beneficiaries. Other factors, however, including your immediate and future cash flow needs, when you plan to retire, your long-term goals, and your other retirement income sources will help determine an optimal distribution strategy.
Regardless of the nature of inherited assets, whether they are held in trust or directly distributed, the advice and guidance of a trusted advisor can make all the difference between receiving a legacy that endures or a gift that quickly disappears. When is the best time to sit down and discuss an inheritance or windfall? Ideally, long before you ever receive it. Knowing that you will receive a sizable amount at some point in the future can open up a world of new planning opportunities and impact how best to direct your existing portfolio assets. If you anticipate receiving assets in the future, please consider talking with your BLB&B financial advisor in advance of this event.