Passing Along an Inheritance? Five Tips for Preparing Your Heirs

Carol J. Clouse, Contributor, Reuters Solutions, First Republic Bank
July 11, 2017

Talking to your children about their inheritance does not come easily. It's common for parents to worry that the knowledge of a future windfall will zap a child’s ambition. But by staying quiet because of their desire to raise financially independent and responsible children, parents risk the opposite result: an unprepared heir who squanders the money. Indeed, 70 percent of wealthy families lose their wealth by the second generation, and a stunning 90 percent by the third, according to The Williams Group wealth consultancy.

This means that talking to your children about their inheritance and preparing them for the responsibility that comes with acquiring family assets — from cash and stocks to real estate, artwork and jewelry that can also have sentimental value — is vital to their future.

A difficult conversation

Unfortunately, many people don’t have these conversations with their heirs. An April 2017 survey by First Republic and Ipsos found that while 82 percent of respondents felt comfortable talking generally about money with their children, 42 percent had told their heirs (children, spouses or other loved ones) nothing about their inheritance, and only 29 percent had discussed specifics with their inheritors.

The main reason for this is fear, says Alan Zafran, Senior Managing Director and Wealth Manager at First Republic Investment Management. “The number one concern from parents is that they’re going to steal their children’s ambition; that the moment they give them money, they might think, ‘I don’t have to work hard, the money is just waiting for me,’” Zafran says. “So parents often feel they’re not allowing their children to learn the life skills — perseverance and hard work — that allow them to develop their own sense of self-worth and self-esteem. Parents think they’re stealing that all from their children if they hand them money.”

So how does a parent best ensure a successful wealth transfer?

Zafran says it helps to begin early by introducing the notion of saving. One common, early strategy is to give an allowance that the child must divide between savings, spending and giving. “It’s an incremental process that starts with educating your child about the importance of living within your means,” he says. “Then as your child ages, you introduce the nuances and details about how to manage money, as well as the idea that money is simply a resource, not a substitute for someone’s self-worth and values.”

IPSOS_infographic_final_gold 6-26-2017.jpg

The survey respondents agreed on the importance of instilling values, with 48 percent ranking this as the most important thing one can pass on to children or grandchildren. In contrast, just 16 percent identified financial assets as the most crucial thing to pass on, while 17 percent cited the value of education and 15 percent ranked a strong work ethic at the top.

The conversation about inheritance can be uncomfortable, especially if there are complicated family dynamics. However, it’s far more likely that conflicts among siblings or other family members will arise when they are grieving the loss of a loved one and the estate hasn’t been previously discussed. Ideally, once the children are old enough to know the details of their inheritance, it’s helpful to involve all the siblings equally and talk to them together, family-meeting style if possible. This can be an opportunity for parents to communicate their values and their wishes for their legacy.

Consider an intermediary 

Deciding how to split an inheritance is a personal choice, and every family’s situation is different. Sometimes, one child has special needs — in which case a special needs trust might be in order — or issues that could cause problems with money management, such as drug abuse. If the money will not be shared equally, or there are complicated family dynamics, it might also be beneficial to include an intermediary, such as an estate attorney or financial advisor, to help with the discussion.

“There may be a situation in which parents don’t want to distribute money equally among inheritors, and sometimes an intermediary can help explain that in a way that prevents a disruption of the family structure,” Zafran says. “Intermediaries play a better role when family structures are sophisticated and/or family dynamics are complicated — for example, a divorced family with two sets of kids.”

Tips for getting started

Another piece of advice: If you have a financial advisor, introduce him or her to your children. The majority of Americans (67 percent) do not use financial planners, but of those who do, 58 percent have not made the introduction to their children, the survey found. Advisors can play a crucial role in kick-starting a financial conversation with heirs —and steering them away from post-inheritance pitfalls.

Below are other strategies for preparing an heir from Robert Pagliarini, author of The Sudden Wealth Solution: 12 Principles to Transform Sudden Wealth Into Lasting Wealth.

  1. Give your kids a financial test. If you’re wondering how your children will handle their inheritance, see what they do with a smaller amount first. Do they save it? Do they pay off debt? Giving them the opportunity to make their own choices with a smaller amount can give you an indication as to how responsible they'll be with a larger windfall.
  2. Tie distributions to ages and events. Many parents create their trust so that their children receive a small amount of money each year, with larger amounts when they reach certain ages (e.g. 30, 35, 40). They also allow for trust distributions to pay for college expenses, weddings, or down payments on a home.
  3. Use incentive trusts that tie distributions to specific, objective conditions, such as salary or educational achievements. A common incentive calls for trust distributions that match the child’s income. For example, if Lisa earns $75,000 annually from her job, the trust will distribute to her $75,000 each year. A parent can add language that will ensure distributions if the child is involved in a non-profit. A disbursement can also be made when the child graduates college.
  4. Get the children involved in a personal foundation. Creating a personal foundation can be a wonderful opportunity to support causes the family believes in, provide tax advantages, and teach kids about money.
  5. Give without giving cash. For example, pay down an adult child's mortgage principal or school loans. This will make a significant difference to the child's future financial position, while not putting that amount of cash in their hands today.

The strategies mentioned in this article may often have tax and legal consequences; therefore, it is important to bear in mind that First Republic does not provide tax or legal advice. Investors' tax and legal affairs are their own responsibility and readers should consult their own attorneys or other tax advisors in order to understand the tax and legal consequences of any strategies mentioned in this document.

This article is presented as-is.