the navigator

Although Millennials are usurping them in other areas, Baby Boomers still have a firm grip on much of the country’s wealth. According to a Cerulli Associates study, Boomers should remain the wealthiest generation until 2030 at the earliest. Moreover, it is expected that Boomers will transfer $68 trillion to their successors over the next 25 years. Such an enormous transition of wealth can create challenges for both grantors and their beneficiaries. In this Navigator, we first discuss some strategies that older investors should consider in order to help ensure a smooth and efficient transition of wealth to their heirs or other beneficiaries; furthermore, we discuss how those beneficiaries can prepare themselves for the complexities that often accompany newfound wealth.

Navigating the Challenge of Giving and Receiving Wealth

The finances of wealthy individuals can be complex, especially with a myriad of assets, accounts, retirement plans, and alternative assets such as artwork or collectibles. Undoubtedly, the complexity that comes with wealth is a good problem to have, but it also means that transfers of estate assets require more careful planning to ensure that assets are protected and that the transference of wealth proceeds as intended.

Wealth Transfer Challenges for Grantors

How can a wealth transfer go wrong? Assets could end up in a probate court after your death, or inadequate planning could lead to family strife and courtroom battles between heirs. Your heirs could lose significant sums to estate taxes at both the Federal and state level, which may have been unnecessary. Your money could be distributed in a manner that is not necessarily in accordance with your desires, or your money could be inherited by someone who is not ready to handle it responsibly.

The consequences of a poorly planned transfer strategy can largely be avoided. By spending the time and money to create a plan and grapple with the necessary decisions today, you are less likely to be left scrambling when sickness or health emergencies become urgent priorities.

The following wealth transfer strategies can help you get your affairs in order:

  1. Create an Estate Plan.
    Who do you want to receive your wealth when you pass away, and how should these beneficiaries receive it? Depending on their age and financial standing, you might want to delay allocations or distribute wealth in stages. For example, a plan giving young beneficiaries one-third of their inheritance at ages 25, 30, and 35 is relatively common.As we have discussed in a previous Navigator, estate planning is essential because it allows you to control aspects of your wealth both during your lifetime and after your death. You will need to decide on beneficiaries, the method of distribution, the executor(s), a trustee or group of trustees, and a guardian of dependents, if necessary. Estate planning can be complex, and estate attorneys are not cheap, but this sort of planning can be extremely effective in protecting wealth and streamlining the transfer of that wealth to younger generations.
  2. Speak to family members who will have a role.
    An invaluable aspect of wealth transfer planning is having conversations with the individuals who will be assigned a unique role in your estate. If you are creating a trust, for example, you will need to decide who will be the trustee to make financial decisions for that trust. An appropriate trustee should be someone who is financially responsible and would handle finances similar to how you would. Generally, good judgment is also an essential quality in a trustee. Trustees are usually friends or family members, but you can hire a professional trustee if desired. You will also want to name between two and four successor trustees in case somebody cannot or will not serve as trustee.
  3. Be proactive with taxes and gifting.
    Taxation is an integral part of your wealth transfer strategy. State tax policies will vary depending on the state, but Federal estate taxes will be exempt at up to $11.6 million per individual in 2020 — an increase of $200,000 from 2019. However, under current law, the exemption reverts back to $5 million in 2026. Certainly, this exemption amount will fluctuate in the future, depending on how estate tax law changes, which happens all too frequently. If you believe that your net worth will be above the Federal and/or state exemption amounts when you pass away, you may choose to try to reduce your taxable estate. One strategy is to make annual gifts during your lifetime that are tax-free up to the exclusion amount, which is $15,000 per recipient for individuals in 2020 or $30,000 per couple. Plus, there is no cap on the number of people to whom you can gift. If you are married and have five grandchildren, for example, you could pass up to $150,000 each year out of your estate. If this option sounds appealing, you should consider creating an annual gifting plan to begin transferring money to your heirs now instead of waiting until after your death.
  4. Pay special attention to retirement accounts.
    The SECURE Act, which went into effect in 2020, reduced the tax-efficiency of retirement accounts as vehicles for passing wealth to heirs. The new rules eliminated the “stretch IRA” strategy, which allowed beneficiaries of inherited IRAs to stretch required distributions from those accounts over their entire lifespan. Instead, beneficiaries must now distribute all inherited retirement assets within 10 years of the grantor’s death, resulting in accelerated tax burdens and reduced opportunities for tax-deferred growth.1 While retirement accounts can still play a key role in your wealth transfer strategy, you should carefully consider the tax implications of these accounts for your beneficiaries as you construct or update your estate plan.
  5. Clue your heirs into the location of your estate planning documents.
    How are your heirs going to find your estate planning documents in the event of your death? We recommend creating a Roadmap for Heirs that addresses this topic and offers resources to help resolve questions that inevitably arise after a death. A roadmap typically includes your estate planning documents, contact information for the people who have been assigned to execute the wealth transfer, and other information that will streamline the wealth transfer process. Because the information contained in the roadmap is sensitive, it is critical to keep it somewhere safe— inside of a safe or a vault in the case of physical documents or protected by a secure password in the case of digital ones. Make sure your heirs know of its existence and can easily access this vital information.

Transferring your hard-won wealth to your heirs or other beneficiaries can be a high stakes endeavor; the stakes grow commensurately with the level of wealth being transferred. However, by building on the strategies we have discussed and developing a sound estate plan, your wealth can continue to carry out your legacy well after you have met your maker.

Wealth Transfer Challenges for Beneficiaries

When a wealthy person passes and his or her wealth has been transferred to the next generation, the challenges associated with stewarding that wealth have also been transferred. This raises the question: does sudden wealth change a person’s approach towards money? The short answer is no. Someone who struggled to manage his or her finances before obtaining inherited wealth is unlikely to magically become adept at managing money once there is a surplus. This is not to say that a person cannot learn how to manage wealth effectively, but the same attributes and flaws that characterized a person prior to becoming wealthy may remain.

What sudden wealth does change is a person’s circumstances. It augments one’s ability and willingness to take risks — and one’s ability to prepare for the future. It can present a beneficiary with additional investment and spending options, but that beneficiary must have specific expertise and knowledge to take advantage of them without opening him or herself up to all manner of new pitfalls.

The Realities of Sudden Wealth Management
Unfortunately, many people who experience an overnight change in wealth have challenges trying to handle the emotional stress, altered personal relationship dynamics, and financial complexity that accompany their new circumstances. Sudden wealth can sometimes be a complete surprise (as in the case of lottery winners), which leaves people unable to plan.

Often, the newly wealthy receive an outpouring of financial advice from friends and relatives. This typically unsolicited advice can be overwhelming and create confusion and paranoia that leads to poor decisions that only exacerbate negative feelings. Especially in the case of an inheritance, which typically occurs in the immediate aftermath of a loved one’s death, sudden wealth can yield feelings of unworthiness and insecurity that further cloud a person’s judgment and prevent him or her from acting prudently.

But it simply does not have to transpire this way. With a proper financial plan in place to guide his or her decision-making, the beneficiary of a wealth transfer can overcome negative emotions and make the most of the new opportunities that are likely to present themselves.

Why Have a Plan?
The old axiom, “failing to plan is planning to fail,” is perhaps never more fitting than when it relates to sudden wealth transfers. Without a financial plan to guide spending and investing, recipients of inherited wealth will likely succumb to the forces seeking to separate them from their money. On the other hand, a thoughtful financial plan can help beneficiaries create good spending and investing habits that should help their wealth last.

A sound plan should include both short and long-term goals. It should provide a complete overview of one’s financial flow, highlight current and projected income streams, and accurately assess current and projected expenses. A good plan should also model a range of possible future scenarios that might affect one’s finances (e.g., adverse health events or early deaths) in order to prepare for both best and worst-case outcomes. Anyone who expects to be on the receiving end of a material wealth transfer should also think realistically about how his or her lifestyle might change with the influx of wealth to ensure that one’s new lifestyle doesn’t outstrip one’s new financial means.

Individuals with significant assets must also consider and understand the tax implications related to their financial dealings, as taxes can often be the most significant barrier to maintaining and growing one’s wealth. A person who has recently inherited or expects to inherit a considerable amount of wealth should seek professional guidance on how to navigate the potentially treacherous tax ecosystem.

In addition to offering expert tactical spending, investing, and tax guidance, financial advisors, accountants, and attorneys can serve as objective and less emotional counterweights to the internal feelings and external actors that trigger compulsive thinking and behavior. For the suddenly wealthy, having access to this kind of measured counsel is often critically important.

Sudden wealth can be a boon or a burden, depending on how one handles it. Wealth inevitably affects a person’s relationships, responsibilities, desires, and, ultimately, happiness. Having a sound plan in place to manage an influx of wealth can help ensure those changes are positive ones.

[1] Exceptions to this new rule include surviving spouses, disabled or chronically ill individuals, and individuals who are fewer than 10 years younger than the grantor.

This article is prepared by Pekin Hardy Strauss, Inc. (“Pekin Hardy”, dba Pekin Hardy Strauss Wealth Management) for informational purposes only and is not intended as an offer or solicitation for business. The information and data in this article does not constitute legal, tax, accounting, investment or other professional advice. The views expressed are those of the author(s) as of the date of publication of this report, and are subject to change at any time due to changes in market or economic conditions. Pekin Hardy cannot assure that the strategies discussed herein will outperform any other investment strategy in the future, there are no assurances that any predicted results will actually occur.