We are currently in the midst of what is being coined as the Great Wealth Transfer — a time during which Baby Boomers are projected to pass trillions to their heirs. Of the $84 trillion anticipated to be inherited by Gen X, Millennial and Gen Z heirs through 2045, $16 trillion will be transferred within the next decade, according to Cerulli Associates.
While these numbers seem staggering, there actually may not be much for younger generations to inherit because of the so-called third-generation curse — when wealth accumulated by one generation is lost by the third generation as a result of mismanagement and imprudent spending.
There are many factors responsible for this third-generation curse, which will affect 90% of wealthy families, according to AMG National Trust, but not all factors are out of wealth creators’ control. Proper estate planning and communication are key factors in a successful wealth transfer, but families often find it challenging to discuss the details surrounding their financial lives with the next generation. In fact, data released by Brown Brothers Harriman last May shows that while 98% of U.S. business owners report that they have an estate plan, 94% have not communicated the plan to their family because of concerns regarding how that information will impact them.
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Determining your intentions
There are many decisions to be made when creating or updating an estate plan, but the real work begins after the documents have been signed. It is crucial for the wealth creator to develop a communication plan that is rooted in the values that drove them to create the trusts or make the gifts in the first place.
Most estate plans are motivated by tax planning, which is a very important factor in transitioning wealth, but not the only one. Understanding and sharing the “why” behind the planning can help avoid the third-generation curse by removing the fear of the unknown that can often lead to misunderstanding among family members, disharmony among beneficiaries and loss of family wealth.
So, how can you get started on this road to communication? The first step is to understand your own values and how they influence the plan you put in place. Keep in mind that your values may be different than those of your heirs, or perhaps they’re the same but manifest in different ways. The purpose of understanding your own values is not to control your plan from the grave by imposing those values on future beneficiaries, but rather to give context to the various structures you have (or have not) put in place.
Understanding these core values can ground you if you face difficult questions from family members regarding the plan and remind you of why you did the planning as it evolves over time.
Building a values-based estate plan
A firm understanding of your core values is an essential step in formulating your intentions for the assets that will be distributed to or held for your heirs. Discretionary trusts are a popular planning technique because of the flexibility and creditor protection they offer, but they can leave trustees in the dark when it comes to decisions regarding distributions. Creating a non-binding side letter of wishes to guide a trustee can help keep the values that informed the planning alive throughout generations and reduce the risk that assets in the trust will be distributed and spent in an unintended manner, thus helping to avoid the third-generation curse.
Explaining why you funded a trust — other than the tax reasons — can be difficult. Writing a letter of wishes requires you to do the work of thinking through what the assets are for (and not) and how you expect them to be used to benefit current and future beneficiaries.
For example, a client may fund a trust with the intention that it be used primarily for education purposes but is hesitant to mandate that in the trust instrument due to uncertainty regarding the future needs of beneficiaries or the cost of education. They could choose to fund a discretionary trust and write a letter of wishes explaining their intention that the funds be used primarily for education (which would be further defined in the letter) and why that was an important, motivating factor in creating the trust. This would allow the trustee to maintain flexibility while ensuring beneficiaries are aware of the purpose of the trust and why certain requests for distributions may be accepted or denied.
Letters of wishes may also provide guidance regarding distributions that may be made if certain circumstances are met. For example, the letter may state an intention that beneficiaries receive certain amounts or percentages of the trust assets at certain ages or upon reaching certain milestones. The trustee would not be required to make these distributions, which is important especially when there are reasons to keep assets in trust for a beneficiary or make payments on their behalf, but guidance like this can be valuable to a trustee administering the trust years after it is funded, especially if they were not involved in the trust creation.
Sharing the plan
Once you have all the pieces of the plan in place, the final step is to share it, but likely not all at once! Sharing information in manageable amounts will keep the attention of your family members and allow them to engage in the process in a meaningful way by asking informed questions. There is no one-size-fits-all approach to this process, but it is often helpful to begin with some basic estate and financial planning education that will serve as a foundation for the information you will share over time and enable your heirs to understand the various components of your plan. This educational element may also be helpful to family members who need to begin their own basic planning.
Next, you might share the work you did to uncover the values that informed your plan. You may discuss your intentions for future generations and how your estate plan is designed to further those intentions and deal with potential concerns.
Many families then move on to sharing information about the various trusts or other entities they have created to pass on wealth. This part of the conversation does not need to include specifics about dollar amounts — it is perfectly acceptable to keep it high-level and focus on the overall structure. You can work with your adviser to anticipate questions that may arise from family members and develop a strategy for dealing with potentially uncomfortable situations, keeping in mind you do not need to have all the answers.
Whether the goal is to pass generational wealth on to your children or not, creating a plan that is rooted in core values and properly communicated at appropriate times will help ensure your wishes are carried out and your legacy lives on for generations to come.
The views expressed are for informational purposes only and do not constitute investment advice or tax advice and are not intended as an offer to sell, or a solicitation to buy securities. Views and opinions are current as of the date of this article and may be subject to change. Neither BBH nor its affiliates provide legal or tax advice.
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This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
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