Prepare your assets for transition to your heirs, but also prepare your heirs to receive your assets. Larry Swedroe explains why the success of an estate plan may depend on preparing families for the transfer of values as well as wealth.
Napoleon Bonaparte was one of the greatest commanders. His campaigns are studied at military academies all over the world. Yet, he developed few military innovations. Perhaps the principal belief underlying his military success can be summed up in this quotation, which is attributed to him: “Most battles are won or lost (in the preparation stage) long before the first shot is fired.”
Each year Americans spend huge sums preparing to transition their assets to their heirs, engaging high-powered estate and tax planners who set up complex vehicles like family limited partnerships, life insurance, charitable remainder, charitable lead and various other kinds of trusts. Yet, despite the best efforts of top-notch professionals, according to Roey Williams and Vic Preisser in their 2007 book, Estate Planning for the Post-Transition Period, it is estimated that “70% of estates lose their assets and family harmony following the transition of the estate.”
Given the talent engaged, the failure can’t be due to poor design. So why do the majority of plans fail?
What do parents worry about most?
Consider the following list, compiled by Williams and Preisser, of the five things parents worry about most with respect to wealth and its effect on their children:
- Too much emphasis on material things.
- Naiveté about the value of money.
- Spending beyond their means.
- Initiative being ruined by affluence.
- Will not do as well as parents would like.
Now, consider the focus of those concerns. While the typical family worries about those issues, the focus of estate-planning professionals is on taxation, preservation of wealth and governance – not on the transfer of family values. Thus, there is an obvious disconnect between the issues that are identified as most important and where the efforts are actually spent. Therefore, it should not come as a surprise when most plans fail. By acting as the “quarterback” on the financial services team, a good advisor will make sure that the tactical and emotional elements of the wealth transfer are given equal attention.
Are your heirs prepared for their assets?
The following are questions clients should ask to determine if their heirs are prepared for their assets:
- Do your children (and their spouses, if any) know your estate plan?
- If not, what would make you comfortable sharing this information? With your children? With their spouses?
- What steps should you take to address your concerns?
- Might there be a plan to provide certain information sooner and other information at a later date?
- Have your heirs read your will and other estate planning documents?
- If no, when do you think is an appropriate time for them to see these documents?
- Do your heirs know the family’s net worth, both yours and their own (if they have assets in their name)?
- If not, when does providing this information become advantageous to you and your heirs?
- Are your heirs in communication with your team of advisors (your attorney, accountant, insurance advisors and financial/investment advisor)?
- If not, would it be useful for family members to meet those people, even if information- sharing is limited?
- Have the children been involved in the formation of the investment policy statement, and are they familiar with the investment strategy, the goals and how to manage the assets?
- If not, when might this involvement be advantageous?
The taboo topic
Unfortunately, in the majority of cases, families treat money and the issues surrounding wealth as taboo subjects. And the “lessons” of non-involvement get passed on from one generation to the next. Thus, in most cases the answers to the above questions are “no” – and that explains why the failure rate is so high.
A recent report from BMO Wealth Management, Estate Planning for Complex Family Dynamics, showed just how poorly heirs are prepared and how that can lead to family discord. For example, they found that 52% of all adults surveyed don’t even have a will, a figure that rose to 56% among adults 35‒54. Among other important findings were:
- 40% thought the distribution of their parents’ estates was unfair, with unmarried adults most likely to feel aggrieved.
- Only 28% of all adults said they knew details of their parents’ wills or estate distribution plans.
- 40% of parents surveyed have never discussed their estate intentions with their children.
Feuds can easily develop when family members feel they haven’t been given their fair share or they have been excluded in the process. Of course, it doesn’t have to be that way. The solution to the problem is that, while it is important to treat family wealth as a private matter, it should not be private within the family. Open communication between parents and heirs can prevent many problems.
Williams and Preisser believe that in order for a plan to be successful, heirs (including spouses) should have some influence in how the estate is structured, or at least have input. They recommend that among the issues that should be addressed is whether the estate plan matches the skills and interests of the heirs. And there should be a plan to prepare the heirs for their future responsibilities. Heirs should know the impact of their wealth on their families and the responsibilities of that wealth.
Achieving an ideal level of knowledge-sharing and family involvement requires its own planning. Each element a family considers “ideal” should be carefully considered and a rollout of an estate transition carefully planned. While each family’s situation is unique, in order to maximize the likelihood of success, a transition plan should, at the very least, address the following issues:
- Have a family wealth mission statement (FWMS) that spells out the overall purpose of the family’s wealth and a strategy to implement it, with roles well defined. See this companion article for best practices on creating a FWMS.
- An FWMS is a superb way to communicate important family values and provide overall direction as future decisions are made. It can be an important standalone activity and serve as a kickoff for the longer transition plan process.
- The entire family participates in the important decisions.
- While families are complicated, finding a way to achieve broad-based input is the surest way to achieve a successful outcome.
- Family members have the option to participate in the management of assets.
- This is a critical issue for certain families, particularly when a closely held business is involved.
- Heirs understand and have bought into their roles.
- This can be a long-term process, and an outside facilitator may play an important role in achieving a desirable and harmonious result.
- Heirs have reviewed and understand all documents.
- While this should be the goal, given different interests and aptitudes, a customized approach that addresses each heir’s needs should be developed.
- Asset distributions are based on readiness, not age, of heirs.
- Too often, distribution provisions are written based on age because of its formulaic simplicity. A more careful, tailored approach is generally better.
- Mission statement includes incentives and opportunities for heirs.
- Since it’s likely that each family, and each individual member, will have different thoughts about what this might look like, many families have found that the best way to achieve a successful outcome is to use an outside facilitator.
- Younger children are encouraged to participate in philanthropic grant-making decisions.
- A good way to pass on philanthropic values early is to begin the process of getting children involved in money issues.
- Family unity is considered an important asset.
- Many families have found that this is a critical factor in helping them work through complicated issues.
- Family communicates well and regularly.
Client family values, as well as current and future goals, should inform the entire financial planning process. Done well, financial planning is about much more than investment management. That is why we begin our relationship with clients with an in-depth discovery process, the purpose of which is to explore and document the client’s values, goals, relationships, assets, risk management, advisors, process and interests.
We ask clients to bring all their estate planning documents (such as wills and trusts) so that we can review them, ensuring they are accomplishing the family’s goals in the most efficient manner and that all documents are up to date. Investment plans are created after identifying the client’s ability, willingness and need to take risk, as well as their ability to deal with the psychological problem called “tracking error regret.”
Then, a well-thought-out investment plan can be integrated into an overall financial plan that includes estate and tax planning, insurance planning and, of course, a plan to transition wealth to the next generations – the FWMS and accompanying implementation plan. Just as most battles are won in the preparatory stage, the success of a family wealth transition plan depends on preparing the family for the transition of not only the family’s wealth but also the family’s values.
Larry Swedroe is the Director of Research for the BAM Alliance.
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The opinions expressed by featured authors are their own and may not accurately reflect those of Beacon Hill Private Wealth LLC and the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.
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