When wealth goes wrong
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While on vacation, I got caught in a poolside conversation about money, as one does when they’re a financial planner. The conversation was about a wealthy family friend who gifted each of their adult children an 8-figure sum of money and how one of the children has already spent the multi-million dollar gift.
It’s incredibly shocking and almost unfathomable, yet it makes complete sense simultaneously. In the wealth management space, we often hear about, and sometimes see firsthand, how the transfer of wealth doesn’t always go as planned.
More Money, More Problems
Several common themes are present in situations where an individual outlives their inheritance. One of the more obvious themes is lifestyle inflation. The presence of a major windfall can make it seem as though all of one’s financial dreams have come true. Many of my clients who have received an inheritance ask to discuss topics like undergoing major home renovations, purchasing a second home, or buying a new car.
An unverified statistic in the wealth management space suggests it takes the average inheritor just 19 days from the date of receipt to buy a new car. I believe it. Lifestyle inflation can also appear as being overly charitable, to the point that the heir has given away an amount of money that negatively impacts their finances.
To combat this, consider hiring a financial planner to determine just how much lifestyle creep you can afford. A good advisor should be able to provide some guardrails on how much an heir can reasonably distribute from the portfolio annually.
You Can’t Teach Drive, But You Can Teach Financial Literacy
Several public figures have publicly declared their intention not to leave their children with an inheritance. At Bedel Financial, we work with private citizens whose wealth is not readily known to the public or their children. This is because many parents choose to hide their wealth. Both tactics are a parent’s way of instilling drive in their kids. When a surprise inheritance catches adult children, the money can sometimes fall into the hands of an unprepared heir.
Do not shy away from money talks! One of the tried and true methods to making wealth last generations is establishing financial literacy. This can be done without showing one’s cards regarding asset base or income level. There is a lifetime of opportunities to discuss banking, investing, borrowing costs, budgeting, taxes, and other financial topics.
Positive signs of an educated heir include someone who has demonstrated the ability to live within their means, saving and investing for their own future, and understanding the power of compounding interest. These goals are within reach for a young adult, so there’s no time to waste!
Values Make it Stick
Sometimes, the loss of generational wealth can be tied back to a disconnect about the greater purpose of money. The older generation must pass along family values, especially if they relate to how that wealth was initially created. Values help guide an heir’s decision-making and shape their perception of money.
For instance, my grandfather on my mom’s side owned and operated a family business. He values the entrepreneurial spirit and several of his children have gone on to hang out their own shingle.
Meanwhile, my grandparents on my dad’s side valued frugality. Their wealth was generated at the end of my grandfather’s career, so much of their lives were spent in a lower economic class. While caring for my grandma in her final years, she would send me to the grocery store to pick up a hot lunch from the deli, but not without a coupon! While my grandparents carry different values, there are important lessons to be learned on both sides.
Trust in the Trust
Sometimes, as with the example in the opening paragraph, an heir cannot properly manage finances. Substance abuse, lack of financial literacy, disruptions to mental health, or other factors may cause some concern when transitioning wealth.
This is where trust comes into play. Establishing a trust is an excellent step to help a troubled heir with the burden of managing an inheritance. With a trust, the grantor can trust that the assets within will be handled diligently by a third party to benefit their heir.
Summary
The greatest wealth transition in history is here! When you pass, you don’t get to take your money with you, so avoiding the common pitfalls of wealth transfer is best. Prepare your heirs, talk openly about money, pass along family values, and don’t be afraid to implement a trust.
Kate Arndt, CFP, is a Wealth Advisor at Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. For more information, visit their website at www.BedelFinancial.com or email Kate at karndt@bedelfinancial.com.