Saturday, October 23, 2021

Trusts Can’t Protect All Inheritances

Trusts don’t teach lessons that are required to maintain and honor wealth, says our columnist.

Deborah Danger
Deborah Danger

It used to be that families passed stories and traditions from one generation to the next.  Fables, the books of the Bible, and holidays are proof that a wealth of knowledge has been retained within our culture, memories and vocabularies. These days, many of my clients focus more on transferring wealth to future generations — and they’re terrified of their wealth winding up in the wrong hands.

As the Silver Tsunami gains momentum — a catch phrase for the trillions of dollars that are expected to transfer from baby boomers to subsequent generations — many clients ask me to draft behavioral restrictions into their estate planning documents.

One client wanted to require that his grandchildren execute prenuptial agreements before marrying in order to gain access to their inheritances. This was done to prevent family money from falling under the control of “money grubbing ex-spouses.”

Other “lifestyle” clause requests are that beneficiaries be disinherited if they cheat on their spouses or fail to raise their children within a particular faith or file bankruptcy. Still others condition inheritances on beneficiaries getting married or having children or remaining thin and not exceeding a certain amount of body weight.

Some states deem such clauses to be against public policy and others unfair or too difficult or unreasonable to enforce. I don’t recommend that clients count on them. Incorporating family values into inheritances is more successful if it’s done by example and patient teaching rather than drafting.

The Real Threat

Preparing for bank-breaking possibilities is a good thing. However, studies show that divorce and bankruptcy are not the greatest threat to the preservation of family wealth. The real threat is the family itself.

According to a longitudinal study that surveyed people in their 20s, 30s, and 40s, roughly half of all money inherited is saved and the other half is spent or lost through investing. As a result, 70% of family wealth is being lost by the second generation, and 90% by the third.

Drafting restricted covenants will never take the place of family values and lessons, but it can supplement them.  Clients should be encouraged to balance each of these elements into their estate plans.

I recommend that any advisor whose clients express interest in applying these restrictive clauses be realistic with them as to what they can accomplish. In addition, I recommend that advisors offer to meet with their clients’ beneficiaries, to help boost their financial awareness and literacy — skills needed to enjoy and preserve the family money to the next generation.

Clients must also have the right estate planning structures in place to protect their assets.

Trusts are Part of the Answer

I am a big fan of trusts. They shield assets from the erosion of taxes and can foster exponential growth of assets if the fiduciary overseeing them is well informed and knows what to do. Trusts can also protect young children from gaining access to too much money too quickly.

However, trusts don’t trump all other rules, and trusts don’t teach the lessons that are required to maintain and honor inherited wealth. Instead, they need to be used in tandem with good education and other legal documents.

When I’m asked to put a client’s money in trust so that ex-spouses of beneficiaries cannot get at the assets, I point out that without a prenup, any money distributed from the trust after the divorce may be vulnerable to alimony and child support orders of the court.

Also, depending on the client’s chosen restrictions, the trustees may be prohibited from making any distributions from a trust because a portion of it may go to the ex-spouse. This rarely is the intention of the person designing the trust.

Sometimes clients want the money their children will inherit from them to be held in trust until the children turn 65. The intention is for their children to continue working and being productive but not have to worry about retirement. However, this plan deprives children of the lifestyle their parents wish for them until they are too old to truly enjoy it. This strategy also accrues excess wealth that is then at the mercy of unrestricted spending from grandchildren and great grandchildren.

“Sudden wealth does not bring with it the required skills, information and emotions to maintain it.”

There’s a reason that many lucky winners of lotteries file for bankruptcy shortly after claiming the winnings. Sudden wealth does not bring with it the required skills, information and emotions to maintain it. Most of my clients’ children have no idea how much they are due to inherit and are ill prepared for when the amount becomes known.

Do your clients’ beneficiaries know how to determine whether their inheritance should be used to pay off a debt or invested in the stock market? The answers are different for each person, but do the beneficiaries know to ask the question and how to analyze the answer?

Education is Critical

To help your client prepare their family for inheriting their money and protecting it from being squandered, here are some talking points you can share with them and encourage them to act on.

Teach what you know. If you made or saved your money and want your children and grandchildren to enjoy and preserve it for future generations, teach them the values and strategies that allowed you to be such a successful saver or generator of wealth.

Take credit for what you did. Accomplishment breeds respect and something to emulate. Many beneficiaries treat inheritances as entitlements. Entitlements are squandered.  Your clients should let their beneficiaries know how hard they worked and how much they sacrificed and instill these values into younger family members so that the legacy is treasured and fostered for all to enjoy.

Actions speak louder than words. Let family members see how you accomplished your wealth.  Clip coupons or start a business together.  Encourage beneficiaries to save for something that’s important and match saved amount.  Teach the miracle of compound interest rather than the pursuit of “keeping up with the Jones.”

Share responsibility for changing the world. Upcoming generations, thanks to COVID, are seeking meaning rather than material possessions.  Many are eschewing inheritances and pressuring older generations to give their money away now in support of charitable causes.  Before doing so, teach them to research and make sure their chosen charity is fiscally stable and able to fulfill its mission.

Let them enjoy your money now … and with you. Why wait until you’re gone to share your wealth? Now that humans are living much longer, children often inherit money when they least need it. A 60-year-old child who already owns a house and has paid for kids’ college expenses may not only inherit money but also an income tax issue. If your kids are in their 30s or 40s, imagine the impact an annual gift of the $15,000 exclusion amount will make on balancing their budgets and paying off their debts. Or, take all of your family members on a trip of a lifetime now, while you can go with them. Make memories! Or, take your grandchild to a charity fundraiser and share the value giving back; that’s a good memory, too.

Additional Reading: Leaving a 401(k) to Charity: What Advisors Need to Know

Give them access to experts. Many of my clients tell me that I’m the first lawyer and professional advisor they have ever spoken with. What? No CPA for tax strategies? No financial planner for investment and retirement planning? No prenup before marriage? I meet people where they are, but if their families had fostered them to seek out good judgement and expert advice, how much further along would they be?

Be patient. The adage shirt sleeves to shirt sleeves captures that in just three generations, family wealth disappears. So, start teaching early and when they are young.  Creating a dynastic trust is one thing, but creating a dynasty of savvy investing, charitable giving, and constant self-improvement for the greater good is a great legacy to leave behind.

Estate Planning and Probate Attorney Deborah Danger, Esq., LL.M. (taxation) is the managing member of DangerLaw, LLC, Newton, Mass. Contact her at deborah@dangerlaw.com.

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