The “Greatest Generation,” as Tom Brokaw has
dubbed those who came of age during World War II, is not just our most
heroic, but also our richest. As those in their late 60s, 70s, and 80s
approach their sunset years, they are prepared to pass on to their heirs the
largest legacy of all time. Some experts estimate up to $8 trillion will
pass from one generation to the next in the upcoming decade.
But as most of us know, money tends to complicate things, not simplify it.
Becoming the recipient of a sudden windfall isn’t the solution to all life’s
problems many expect it to be. In fact, study after study has shown that
people tend to be less happy with their lives after a sudden windfall, not
more so. That’s why those who want to do the right thing by their loved ones
would be well served to carefully consider not only how much to pass on, but
why and when.
CREATING
FAMILY INCENTIVES
Of course, your first duty to your loved
ones is to make sure that they have their basic needs provided for in the
event of your untimely death. That means that a surviving spouse will still
have a roof over his or her head, and that young children will be able to
get the higher education they need for a solid start in life.
You’ll also want to build in safeguards that protect your loved ones in the
event of a serious disability or illness that keeps them from being able to
earn a living wage.
Once you’ve ensured the financial security of your loved ones, however, your
choices get much more complicated. Leaving money outright to young,
financially inexperienced or emotionally immature heirs is like handing a
loaded gun to a toddler. If there’s one thing we’ve learned about inherited
wealth, it’s that it has a corrosive power that often turns otherwise
productive people into adults incapable of earning an income or contributing
anything of value back to society. That inability to contribute often robs
heirs of their sense of self-worth and self-esteem.
John L. Levy has spent at least five years studying how inherited wealth
impacts heirs, and what he has discovered is discouraging: “It’s hard for
[heirs] to take satisfaction in their accomplishments since they always
suspect that their successes are at least partly the result of the wealth
and position they have inherited.”
In response, growing numbers of parents and grandparents are looking for
ways to pass on their values as well as their assets. Creating a family
incentive trust is one of the tools that helps accomplish this goal. For
example, instead of distributing cash outright, parents and grandparents can
write provisions into their estate plans that reward their loved ones for
desired behavior with such financial incentives as:
• Matching an heir’s earned income with a
cash incentive to reward them for being productive.
• Replacing a working parent’s income if he or she stays at home with
young children.
• Providing financial incentives for attending college or earning a
graduate degree.
• Providing financial incentives for maintaining a respectable grade point
average.
• Making up lost wages for an heir who decides to volunteer part-time or
full-time for a charity or who otherwise provides a valuable -- but
nonpaying -- community service.
• Providing seed money to help an heir start a business -- once the
business plan had been approved by outside advisors.
• A cash gift to help pay for a first marriage.
• A cash gift to help buy a first house.
• Money for a grandchild or even great-grandchild’s college tuition.
As valuable as incentives can be, keep in
mind that it’s a careful balancing act between providing loved ones with
incentives for good life choices and becoming an overbearing meddler who
uses money to control a loved one from beyond the grave. Parents who may
have gone to far in this direction are those who offered these incentives:
• Reimbursement for college tuition only
if the heir pursued a professional degree. What if the heir was a gifted
artist or teacher? This kind of incentive diminishes the heir’s chance to
fulfill his or her own destiny.
• A cash bonus for each child born to the heir. Children should be born
into a family that wants them, not one that does so for financial reasons.
• A cash gift at marriage only if the heir didn’t marry a lawyer. No
comment needed here, right?
Finally, while the trend toward setting up
incentives is a positive one, watch out that you don’t create an atmosphere
of punishment for failing to live up to your expectations. You want to help
you children and grandchildren live up to their fullest potential, not
stifle their personal growth or limit their options in life.
SETTING
UP A FAMILY INCENTIVE TRUST
There are as many ways to create a family
incentive trust as there are families. You can create “incentive clauses” as
part of any trust document that allows for the occasional distribution of
funds to your heirs. For example, you could include incentive clauses in
your revocable living trust or your irrevocable life insurance trust.
Or you can take the family incentive trust a step further and create a
special trust that will allow you to extend your financial incentives
through two or even three generations. These are so-called Dynasty or
Generation Skipping Trusts.
Whichever route you take, be sure you appoint wise trustees who have nothing
to gain from your estate plan.
These outsiders should know your family but also be insulated from personal
pressures to make decisions one way or another about your family incentives.
In contrast, putting a loved one in this delicate position can create enough
turmoil and discontent to tear your family apart -- no doubt the last thing
you’d want.
PASSING
WEALTH ON TO LOVED ONES
• In 1986, Fortune Magazine reported that
six of the 30 multimillionaire it surveyed said that their children would
be better off with only minimal inheritances. Half said they would be
leaving as much money to charity as to their children.
• Warren Buffet, the ultra rich investor, plans to leave most of his
wealth to charity to encourage his children to lead productive lives. “The
idea that you get a lifetime of food stamps based on coming out of the
right womb strikes at my idea of fairness,” he says.
• Millionaire oilman T. Boone Pickens plans to leave most of his wealth to
charity instead of his five children. He says, “If you don’t watch out,
you can set up a situation where a child never has the pleasure of
bringing home a paycheck.”
You don’t have to be the last man standing
on the latest “Survivor” to be the recipient of a sudden windfall. In the
heady days of the dot-com boom, stock option fortunes were made overnight.
More recently, average citizens have found their lives transformed by a
sudden windfall earned from an inheritance, divorce settlement, business
buy-out, insurance proceeds, legal judgment, a terminated 401(k), and yes,
even the occasional winning lottery ticket. When good things -- like a
sudden windfall -- happen to good people, bad things can sometimes follow.
According to the Financial Planning Association, 90 percent of windfall
recipients blow it all in just five years. But with careful guidance, you
can keep more of it.
DECIDE ON
THE PAYOUT
Sometimes the first choice you’ll be asked
to make is how you want to receive your windfall: in a single lump sum
payout or periodic distributions. Factoring into the equation is a balancing
act between taxes and the rate of return. If your windfall is ‘parked in a
low-return vehicle -- as you’d find with lottery winnings, for example --
then you may be better off taking the lump sum and following a more
aggressive investing strategy. But that has to be balanced against the tax
bite. While taxes on a $1 million dollar lump sum will be almost $400,000,
the tax on a smaller annualized payout may save taxes overall. The pros and
cons of each option need to be carefully evaluated before you choose a
distribution scheme.
PLAN FOR
THE TAXMAN
Speaking of taxes, sudden windfalls are not
treated equally by the IRS. Some large settlements, such as proceeds from a
divorce or a personal injury lawsuit are usually tax-exempt, while others
are not. So, compute and plan for the tax bite before you spend a penny on
anything else.
PUT THAT
MONEY TO WORK
A $3 million dollar check just sitting in a
safety deposit box for six months? No way, right? Sad to say, we know a
situation in which that’s exactly what happened, because no one had a plan
for investing, saving or spending that money at the outset. While you
probably won’t want to launch into any long-term investment strategies until
you’ve worked out your long-term goals, ask your advisor about short-term
strategies that will yield better results than tucking you winnings in a
mattress.
PLAN FOR
THE COST OF MAJOR LIFESTYLE CHANGES
Studies show the three things windfall
recipients invest in first are houses, educations and vacations. But each
can have a lasting price tag. For example, an expensive home will bring with
it higher property taxes, maintenance costs and insurance premiums. If
you’ve invested all your winnings into property without considering its
ongoing expense, you may quickly find yourself back where you started from
if you can’t afford the upkeep. So, take a close look at the big picture of
any major change in lifestyle, with all the potential new expenses such a
change will bring.
Another lifestyle change that has to be considered is the increased risk of
liability. Your well-lined pockets could become a tempting target to the
next person who slips and falls on your front walk. So, part of your post
windfall survival strategy should probably include an increase in property
and casualty insurance as well as any other liability coverage you may have.
RE-EVALUATE YOUR ESTATE PLAN
A large windfall may have the biggest
impact of all on your estate plan. The infusion of new money, for example,
is likely to increase your estate tax liability -- or create one if you
didn’t have one before. Careful planning will help you reduce taxes as much
as possible. But in addition, with newfound wealth comes a greater
responsibility to use it wisely and preserve more of it for loved ones, as
well as to help ensure that heirs use it just as wisely as you do. That’s
just the kind of need that an estate plan is intended to fill. Estate
planning will also help you with such cherished goals as charitable giving,
and it can even help provide you with asset protection strategies to
discourage nuisance lawsuits and other spurious legal action. So, before you
set off for that trip around the world in a hot air balloon, give us a call
to discuss how estate planning can help you keep more of your newfound
wealth. |
