Planning Multigenerational Wealth
Planning multigenerational wealth isn’t something most of us give much thought to.
Instead, we think of the Rockefeller or Vanderbilt heirs who have lived a privileged life ever since their founders built monopolistic empires.
The closest most of us will come to building monopolistic empires is probably… well, in Monopoly.
However, that shouldn’t stop us from thinking through how our impacts can spread across multiple generations. Or how your parents’ or grandparents’ impacts could spread multiple generations.
If there’s no plan, it could create a less than optimal situation when the time arises.
How should we think about planning multigenerational wealth?
Multigenerational wealth is a subject that can get incredibly complex. Instead of covering the gambit of issues and strategies, let’s talk through some high-level ideas.
Depending on your planning needs, it could require a team of accountants, attorneys, and wealth managers. However, it can also be pretty simple. Let’s go through some basics:
Topic 1: Estate Planning
Estate planning includes the management of your assets once you pass. At a high level, you have three options for estate planning:
- Do nothing
- Create a will
- Build a trust
1. Do Nothing
According to Caring.com, in 2020, only 32% of surveyed individuals had any estate planning documents.
Dying without a will or intestate means your state probate process kicks in, which can get complicated.
Your state will assign a personal representative (usually family) who will go through the difficult process of distributing assets.
This situation is playing out now with the tragic death of the actor Chadwick Boseman. He didn’t have a will, so his wife is petitioning the state of California to become the administrator of her late husband’s estate.
It should be pretty cut and dry, but they’ve only been married a year, so there’s a chance not all of their property is “community” property, which means any of Boseman’s non-community property could be split between his wife and parents.
Anyway, you can see how this can get complicated. Dying intestate is irresponsible, in my opinion, because it put the onus of management and decision making on someone else.
2. Create a Will
Creating a will puts you ahead of most people in the estate planning process, but it’s no magic bullet. While it defines how you want your assets distributed, everything still goes through probate.
You can create a will online or through an estate attorney, and it doesn’t take very long.
If you don’t have kids or many assets, you might be okay with a will, but it’s worth paying for a trust for most people.
3. Build a Trust
If you want a bulletproof plan for distributing assets and fulfilling your wishes, a trust is the way to go. If set up properly, the trust will skip the probate process altogether.
A trust allows you to define exactly how you want to distribute your assets, and you can also add rules as to when assets can be distributed.
For example, if you leave your assets to your children, but you don’t want them to get any of it until they’re 26, a trust is used to create these rules and limitations.
The Downside of a Trust
The biggest downside of a trust, and why many people don’t have one, is the associated expense. If you go to a traditional estate attorney, you can easily pay thousands of dollars.
However, there are many online “disruptors” who are bringing the price way down. I partner with Trust and Will, who can create a trust much cheaper.
One thing you can do now, even before creating a will or trust, is to name beneficiaries for all of your financial accounts. This includes checking accounts, brokerage accounts, IRAs, 401(k)s, etc.
To do this, call or log in to your account, and there should be an area on the site to name your beneficiaries.
If you have a beneficiary named and you die, your beneficiaries will receive your money even if you don’t have a will or trust.
Topic 2: Inheritance
When most people think about inheritances, they picture the attorney coming in after a loved one’s death to read the will. Everyone’s on the edge of their seat, waiting to hear if Junior got cut out.
While this makes for a nice drama, it doesn’t make for great planning!
There are many strategies to think through on both sides of the inheritance discussion. Let’s go through a couple:
- Legacy wishes
- Tax consequences
1. Legacy Wishes
If the first time legacy wishes are heard is at the infamous “reading of the will,” someone did something wrong.
Ideally, the older generation should work with the younger generation beforehand to communicate their legacy wishes.
Of course, this could go downhill quickly if the wants and wishes don’t align, and Grandma gives all her money to the pet shelter, but it gives everyone a chance to get on the same page.
Maybe my goal is to fully fund my grandchildren’s college tuition through a 529 plan, but that means I won’t have any money for my kid’s inheritance.
If this is communicated beforehand, my kid could properly plan by not fully taking on the burden of saving for their kid’s college and instead focus on their own retirement.
2. Tax Consequences
Tax planning can be one of the biggest misses when not planning multigenerational wealth. There are serious tax consequences depending on how money is given to the next generation.
Current tax law allows a “step-up” in basis, meaning the “cost” of the investment is based on when you receive it, not when it was originally purchased.
This is a huge advantage because if your parents bought stock fifty years ago, that’s gone up 10,000%, they would owe a huge amount of taxes on it, but the step-up means you won’t owe any taxes after you inherit it!
However, if you receive the full inheritance with an IRA, the set up doesn’t apply since it’s all pre-tax. Instead, you’ll be forced to liquidate the IRA within ten years of inheriting it.
This could have a huge impact on your income taxes, as all the IRA money you’re forced to distribute will count as income, pushing your taxes way up.
If you inherited an after-tax brokerage account instead, you’d have ZERO tax consequences.
It takes some planning and foresight to have these conversations, and it takes some flexibility with the older generation.
They’d have to be willing to pull income from their IRA while they’re still alive, instead of after-tax accounts, and then pay the income taxes on this extra generated income.
It would make their taxes go up, but assuming their income is much lower than your income, the tax burden will be much lower with this strategy.
Case Study: Tax Consequences from Inheritance
Let’s take a look at the differences in receiving an inheritance via an after-tax brokerage account versus receiving via an IRA.
We’ll use the same example family for both scenarios:
Jonas and Jane are married, file their taxes jointly, and don’t have any kids. They take the standard deduction on their taxes.
- Combined Income: $200,000
- Standard Deduction: $24,000
- Taxable Income: $176,000
Scenario A (IRA): They receive an inheritance from Jane’s Grandparents
- Total inheritance received via an IRA: $500,000!
To satisfy the 10-year rule, they’ll take equal distributions of roughly $50k for each of the next ten years.
Their Income is in the 24% tax bracket, and luckily the extra $50k won’t put them up another bracket.
However, their federal taxes on the $50k IRA distribution will be 24%, or $12k extra per year! This amount could be higher, depending on their state income.
There are some strategies to help offset the tax impacts like starting a Donor-Advised Fund, but it still means you’ll get less money.
Scenario B (after-tax brokerage): They receive the same $500,000 inheritance, but it’s all in an after-tax brokerage account.
Since all of their investments are “stepped up,” their cost basis automatically resets to $500k.
There are no obligations to distribute assets since it’s all in an after-tax account. Jane and Jonas are free to do whatever they want with the money!
Any growth after the initial step-up will get treated as capital gains tax when you sell.
This one difference in inheritance strategy means tens of thousands of dollars of differences in taxes.
Having the Inheritance Discussion
For most people, having the inheritance discussion is too personal. We have a hard enough time talking about money, now add in the challenges of family and inheritances!
The best way to approach it is with love and the goal of ensuring you understand their legacy wishes.
How will their wishes be honored if they’ve never had the discussion? Also, as we discussed, it can save a lot of money when done correctly.
