Reports show lump-sum distributions are a disaster for retirees. For about 7 million Americans, the fruits of decades of painstaking money management will evaporate just as fast. Protect your clients as well as their heirs.
The typical inheritance isn’t huge, but research going around the industry now indicates that a lot of little bequests are being squandered fast enough to add up to a whole lot of AUM.
With an estimated $4 trillion in play as the Baby Boom shifts from retirement to estate planning, it looks like as much as $1.3 trillion will trickle away over the next five to seven years.
Do the math and 35% of all inheritances get cashed out within two years, leaving the heirs in the exact same financial position if not actively worse off.
That means that even if you keep those second-generation clients on your books, they’ll still be gone in 24 months. And that $1.3 trillion across roughly 7 million retail accounts will disperse.
With math like that, making sure wealthy clients structure their bequests to last becomes a little more than a nice parting gift: for advisors who want to outlive the Baby Boom, it’s a strategic necessity.
Even large inheritances disappear fast
Ohio State University researcher Jay Zagorsky’s groundbreaking study of cross-generational wealth transfer is making industry headlines again because the numbers are striking.
Even when big bequests above $100,000 are at stake, all the money disappears 18% of the time. The heirs spend it all and end up without a lot to show for it.
If anything, net worth remains flat or drifts lower within two years of the transfer. As the checks shrink, the odds of a spend-through scenario climb. By the time you’re looking at $1,000 distributions – where a lot of middle-class grandkids and great-grandkids end up – a full 40% of the money vanishes into the household budget.
Forget “rags to riches to rags” in three generations. These pockets of hard-won capital are gone in a matter of months.
Granted, a $1,000 bequest is extremely susceptible to erosion. But roll 50 of them into a small trust, and the money can last a little longer and make a bigger difference overall.
Find a trust administrator willing to take on a project on that relatively small scale for a reasonable fee, and each of the 50 descendants may end up drawing $100 a year in something like perpetuity.
While it’s not a huge impact year to year, after the first decade the beneficiaries stand to make more money to save, spend or reinvest than they would if the estate plan had gone the individual lump sum route.
Obviously, the more money there is to work with in the first place, the more the pooled trust approach makes fiscal sense. Distributions can also be timed to minimize tax liability for those who may not welcome added income this year but may welcome it in the future.
Special purpose trusts can make money available for use in circumstances your client approves in life: college degrees and charity, not motorcycles and speedboats. If the money isn’t used in the right way, no distribution is made – the money keeps building.
And as long as the capital remains at work, the advisor calling the investment shots doesn’t have to worry about losing the account and the associated fees.
Trust Advisor readers are familiar with how frequently the heirs take the money elsewhere when a client dies. When the money gets spent, the AUM doesn’t even transfer to a rival advisor.
That’s great news for car dealers and cruise lines. Maybe in time the people making money in those businesses will open advisory accounts and bring the money home, but in the meantime it’s a $1.3 trillion loss for the money managers.
Furthermore, even those who save “most” of their inheritance are spending down quite a bit of it. Zagorsky estimates that in all the total wealth transfer drag on the industry may be closer to $2 trillion through 2022.
Annuitize the payments, remain present
We all know that retirees who cash out with a lump sum tend to do worse than those who annuitize their nest egg in some way.
The psychology isn’t hard to understand: it’s tempting to nibble away at a big pool of cash until it disappears. Meanwhile, unless the money rolls back into a competently managed investment vehicle, it’s not going to grow faster than ambient inflation.
Managing the inheritance works a lot like managing the retirement account in life. The only difference is that the heirs probably have a longer theoretical lifespan ahead of them to draw down the assets.
Naturally, everything depends on how your clients hope the money will change their descendants’ lives and how much they trust their heirs to spend it responsibly.
If a particular heir apparent isn’t up to the challenge, a trust with annuitized distributions ensures a better overall outcome. Those who would have been careful with the money anyway won’t mind the added supervision if it means more wealth over time.
In the meantime, your client remains active in absentia because the checks keep coming, and the more detailed the distribution policy is, the stronger his or her posthumous voice will be.
Given the choice, I think a lot of grandparents would prefer that scenario compared to the check and oblivion. The advisors, needless to say, get to keep an eye on some of that $2 trillion for a longer period of time.
It’s a win for the client, even at mass affluent levels that would ordinarily not require a trust for tax purposes. It’s a win for the beneficiaries. And it’s a win for the industry.