In our last blog post, Sudden Wealth: How to Handle a Large Inheritance, we discussed what beneficiaries should do upon receiving an inheritance. This post shifts the focus to parents and how they can prepare their finances so their children’s inheritance doesn’t become a burden.
When planning for the future, the primary focus is typically on growing wealth, but few take the necessary steps to ensure their estate is passed on to the next generation efficiently. Consider the case of Bill, a successful professional who accumulated $3,000,000 in assets over the course of his lifetime.
Bill was never one to openly discuss his finances with his family. His goal was for his three children to share his assets equally when he passed, and he had an attorney create his Last Will and Testament 10 years earlier to formalize his wishes.
Over the years, Bill had accumulated a number of assets by investing through his 401k at each job he held throughout his career. In years when he had excess cash, he would consider additional investment options which resulted in a few small annuities, two whole life insurance policies, two brokerage accounts with different financial advisors, and bank accounts and certificates of deposit at three different banks.
Bill had plenty of assets to provide for his needs and always assumed that whatever was leftover would go to his children and would be “icing on the cake” to their financial situation. He wasn’t too concerned with how his estate would be handled. If it took a little effort for his children, that would be fine because they would be receiving the assets which would more than compensate them for their time.
Bill recently passed away. Because Bill never discussed his finances in detail with his family, his children had no idea what assets he had or where they were located. After the funeral and while they were still going through the grieving process, they began to clean out Bill’s home and sift through his paperwork looking for old statements of any financial accounts he had.
Once they found his primary bank account, they began reviewing transactions to gain additional clues. Recurring payments gave some indication that there were life insurance premium payments being made, but little indication of which company the policies were with. Similarly, recurring deposits indicated money transferring in from an annuity, but again very little information was provided.
Gradually, as they continued sifting through Bill’s paperwork stashed in his file cabinet, they were able to locate multiple outdated statements for various accounts. After weeks of calling phone numbers and being transferred to different departments, they obtained more information on a few of the accounts.
Some accounts were no longer open, and others required significant back and forth to confirm the existence and details of the account. While they could never be sure, Bill’s children believed that after six months they had likely located his major assets.
Bill’s children identified the following assets:
- His home valued at $700,000.
- A traditional IRA with a balance of $1,500,000. This account originated when Bill rolled over his 401(k) from his first job and then simply let it grow for decades. When Bill set this account up, his third child hadn’t been born, so only two of his three children were listed as beneficiaries.
- Two small life insurance policies with a total death benefit of $100,000.
- Three $50,000 annuities that will be paid out to his beneficiaries.
- Two 401(k) plans with $100,000 each from previous employers.
- Two brokerage accounts that were established by different financial advisors.
- Bill also had checking accounts at two different national banks. In addition, he had recently purchased a certificate of deposit at a local bank during an interest rate promotion.
The result? A complex, time-consuming, and emotionally draining process for his family to identify the assets, establish their authority over the assets, and transfer the assets.
Further, when it was all said and done, his children were no longer on speaking terms. Why? Unfortunately, in all the financial clutter, Bill had mistakenly believed that his Last Will and Testament, which left everything equally to his children, would ensure they were all treated fairly.
What Bill didn’t understand was that beneficiary designations take priority over his Last Will and Testament. As a result, Bill’s traditional IRA was paid out to his two oldest children since they were the only named beneficiaries. This resulted in the two oldest children each receiving $750,000 more than their younger sibling.
Further, there was no easy solution to fix this mistake because any distribution from the newly inherited IRA balances would cause a taxable event to the older siblings, and any gift to their younger sibling would require them to file a gift tax return reducing their own lifetime exemption.
In the end, Bill’s family spent hundreds of hours trying to resolve his estate and ultimately ended up destroying family relationships.
Bill is a fictional example of very real problems that families encounter on a regular basis. Over the course of a lifetime, many individuals accumulate a complex financial web of accounts and assets that eventually will have to be untangled.
Individuals who ignore the financial mess are simply creating a burden for those who have to settle their estate in the future, often creating significant conflict and issues as a result of having no estate plan or improperly implementing the plan they have in place.
Key Takeaway:
By failing to create a well-structured estate plan, many families force their children to spend months sifting through paperwork and often create significant conflict between their children.
Where To Start?
The first place to start is with a clear understanding of your financial situation. Take an inventory of all the assets and debts that you have and consider whether there are ways to simplify your finances.
Consolidate Your Investment Accounts: If you have multiple brokerage accounts, consider merging them into a single account. Similarly, if you have multiple 401(k) accounts from prior employers, consider merging them into a single rollover IRA account.
You can continue to hold the same investments if you choose but having them in one account reduces the administrative work of monitoring beneficiary designations, streamlines the process of retitling accounts as you implement your estate plan, and decreases the administrative process of transferring assets when you pass away.
Reduce Redundant Bank Accounts: Instead of multiple bank accounts with small balances, consider maintaining just one primary checking and one high-yield savings account. The checking account can be used to facilitate payments, and the high-yield savings account can hold any excess cash that serves as your emergency fund.
If the balances are below the FDIC insurance limits, there is little reason to add additional accounts at different banks. If the balances are close to FDIC insurance limits, it is likely worth considering whether there is a need to hold so much cash. If there is, then consider whether a high-yield cash account that can provide greater FDIC insurance coverage than the typical bank would be an appropriate choice. A good example would be a Flourish Cash account.
Evaluate Certificates of Deposit (CDs): High-yield savings accounts typically offer competitive interest rates to most CDs with much greater flexibility. Even if a CD provides an additional 0.2% interest, is it worth the additional time, complexity, and restrictions?
By compiling an inventory of your current financial life and streamlining what you can, you will save time and money while reducing the chances of problems in the years ahead.
Key Takeaway:
Start by taking an inventory of your accounts and consolidate them when possible.
Define Your Estate Plan Clearly:
Once you’ve simplified your finances, it will be much easier to review and revise your estate plan to ensure it meets your wishes. The first place to start is to consider how you would like your assets to be divided.
Once you know this, your estate attorney can help draft or revise your estate plan to match your wishes. One common mistake individuals make is believing that drafting their Will or Revocable Trust document is all that is necessary to implement their estate plan.
In reality, they need to take additional steps to ensure their assets are titled in accordance with that estate plan. Often the estate attorney will provide an “Asset Titling and Beneficiary Letter” which lays out how each asset should be titled and who should be listed as beneficiaries.
If the asset titling is not updated or the beneficiaries are not changed to match the recommendations, the estate plan is likely to fail. Accordingly, it is important for each family to review their estate plan to ensure their plan is appropriately implemented. A good starting point is to:
Revise Estate Planning Documents: Keep your Will and Revocable Trust documents current. Often it is good to review these documents with your attorney after major life changes or at least every 5-10 years to make sure they still reflect your wishes.
Review Asset Titling and Beneficiaries: Ensure assets are titled properly for seamless transition, and regularly check IRA, 401(k), life insurance, and annuity beneficiaries to ensure they match the recommendations in your estate plan.
Communicate Your Wishes: If inheritance amounts vary among your heirs, have a conversation to explain your reasoning and to prevent disputes among your children in the future. It is important to clarify that an unequal distribution is intended rather than leaving your children to guess whether it was simply an oversight in your estate plan.
Key Takeaway:
Drafting a Will or Revocable Trust document is not enough to guarantee the estate plan is implemented as intended. Additional steps need to be taken to ensure each asset is titled correctly and the beneficiaries are consistent with your wishes.
Organize a Legacy File:
Imagine being responsible for settling a close friend’s estate with no prior knowledge of their finances. How would you start? What information would you need? Your children will face the same challenge if you don’t provide clarity. We recommend that you prepare a legacy file that includes:
- A List of All Assets, Debts, Insurance Policies, etc.: Include account numbers, financial institutions, and contact information.
- Access Information for Each Account: Include website URLs, login credentials, and security details. A password manager can simplify this process because it allows you to keep the single master password in your legacy file rather than having to update all the underlying passwords within the legacy file each time one changes.
- Estate Documents: Store updated copies of your Will, Trusts, Power of Attorney, and Healthcare Directives.
- Safe Deposit Boxes: If you have a safe deposit box, make sure to include details in your legacy file so your family knows how and where to find it.
- Other Important Documents: Keep copies of other important documents in your legacy file as well such as birth certificates, marriage certificates, Social Security cards, etc.
- A Family Letter: While legal documents dictate asset distribution, a personal letter can offer guidance on any relevant financial or sentimental matters.
Finally, once you’ve gone through the effort of creating your legacy file, make sure to let your family know that it exists and where it’s located. For some, it may be a physical file in their safe, and for others it may be a folder on their computer, but either way, it will only serve its purpose if your family can find it.
Key Takeaway:
Create a legacy file that organizes all the important information your family will need and let them know where to find it.
Simplification Benefits You, Too:
Streamlining your financial situation isn’t just a favor for your family – it also makes managing your finances easier while you’re alive. Fewer accounts, simplified investments, and a structured estate plan can significantly reduce stress for both you and your loved ones.
If you are currently working with a financial advisor, ask yourself: Are they helping you simplify your financial life or adding complexity by selling products without an understanding of your bigger picture? A great advisor should:
- Sit down with you and understand your entire financial picture as well as your unique goals and values.
- Help you consider whether your estate plan is clearly defined and appropriately implemented.
- Work with you to facilitate the process of consolidating and organizing your accounts.
- Provide comprehensive financial guidance throughout the process.
Many individuals accumulate multiple financial advisors throughout the years. For those who have multiple financial advisors, consider consolidating with a single, trusted advisor who can provide support for the rest of your lifetime and can facilitate the transition to the next generation when the time comes.
When seeking this single, trusted financial advisor, consider working with a fiduciary, fee-only, independent advisor. While only a small fraction of advisors meet all three of these criteria, we believe the commitment to working with a fiduciary, fee-only, independent advisor is critical because it creates an environment of trust where you can receive advice tailored to your situation rather than a transactionally focused sales pitch.
To understand why working with an advisor who is fiduciary, fee-only, and independent is critical, it is important to understand what each of these terms mean.
Fiduciary: A fiduciary advisor is legally required to put the client’s interest first. The fiduciary standard is the highest legal standard for a financial professional. Many financial professionals are not held to a fiduciary standard at all, and some are held to a fiduciary standard in only a portion of their responsibilities. Talk about confusing! The key for a prospective client is to ask whether the advisor is legally held to a fiduciary standard 100% of the time.
Fee-Only: The simple definition of fee-only is that the advisor does not receive commissions for selling products. Receiving commissions creates a significant conflict of interest because the advisor is incentivized to make a sale which may or may not align with the client’s goals. Advisors who are fee-only eliminate this conflict of interest by avoiding commissions entirely.
Fee-only advisors receive all their compensation directly from the client which removes the chance that a potential commission will shape the advice given.
Independent: An independent advisor has the freedom to choose the investment options that are best for the individual client’s situation. Advisors who work for a larger financial institution are often restricted to offering only the specific financial products of their firm.
An independent advisor has the flexibility to recommend what is best for your unique scenario and is not restricted to the investments of any specific financial institution.
In the end, working with a fiduciary, fee-only, independent financial advisor can be the key to receiving quality advice today and ensuring your finances are a blessing for future generations.
Key Takeaway:
Having a fiduciary, fee-only, independent financial advisor can help you ensure your finances are organized so they are a blessing, not a burden, for future generations.
Conclusion:
While growing wealth often takes priority in the early years, giving thought to the next generation and the family members who eventually will be responsible for transitioning your wealth is critical.
Leaving your family a well-structured estate is one of the greatest gifts you can provide. By simplifying your financial situation, clearly defining your estate plan, and organizing a legacy file, you can ensure that you do not add an unnecessary burden on your family as they begin the next phase of their lives.
In a world where so many families are left with financial disorder that creates a burden, you can leave your family with a blessing.
If you are interested in learning more about working with a fiduciary, fee-only, independent financial advisor to ensure your financial life is organized, one of our Family CFOs would love to connect to see if what we do is right for you.
