The Family Fortune: `Can We Talk?'Joan Warner
Blessed are the baby boomers, for they shall inherit--about $6 trillion. Thanks to the robust economy of the '50s and '60s, generous entitlement programs, and their own frugality, the Clinton generation's parents are the wealthiest Americans ever. Over the next 25 years, their booty will pass down in a wealth transfer of unprecedented size.
Is the Big Chill crowd ready for it? Even a modest inheritance requires tax and legal planning and raises emotional issues for a family. When parents have substantial assets, the failure to address these concerns can mean the difference between a loving legacy that provides years of financial security and a nightmare of self-perpetuating problems.
Estate-planning experts say heirs commonly make two big mistakes: First, out of fear of offending their parents, they remain too passive about the inheritance process or don't get involved at all. That sets the stage for trouble later on, from squabbles with siblings to unexpected burdens such as pension distributions. "I can think of a lot of people who wish they had talked about it," says Ross Nager, executive director of the Arthur Andersen Center for Family Business in Houston. Ideally, parents should bring up the subject. If they don't, Nager suggests children start by saying: "I hope you won't misinterpret this. My siblings and I want to understand your intentions with respect to your estate."
The second mistake is acting too quickly right after an inheritance. When heirs receive a windfall, says Nager, "all of a sudden, they're besieged by money managers, people selling the Brooklyn Bridge, the works." Instead of making a fast, irrevocable decision about how to invest, put the money in something safe and liquid--even a low-paying money market account--until you have formed a long-term game plan.
BE PREPARED. Better still is to have one in place long before the will is read. The tax consequences of poor planning can be enormous. Anything over $600,000 left in a parent's estate--$1.2 million for a couple filing jointly--is subject to federal, state, and local taxes that can add up to a rate as high as 66%. With some foresight, a family can reduce the Internal Revenue Service's cut quite a bit. One way is for parents to make regular gifts during their lifetime. A couple may give away $20,000 a year to each child tax-free, to bring their estate down to the $1.2 million exemption level, provided they make the gifts at least three years before they die.
Even if parents have much more to give away, lifetime gifts can be smarter than bequests, because gifts are taxed differently. Say a couple has $1.5 million over and above their $1.2 million transfer-tax exemption. If they leave it in their will, their kids will get about half of it, and the IRS gets the other $750,000. But if the parents give the $1 million outright, they'll owe only $500,000 in gift taxes. So the children receive $250,000 that the government would have gotten after the parents' death.
Another way to shelter cash from estate tax is to funnel some to grandchildren. Each grandparent can give away as much as $1 million without paying generation-skipping tax, which is like estate tax plus income tax. They can also give grandchildren--or other beneficiaries--unlimited amounts for educational or medical expenses, tax-free. The only requirement: Payments must be made directly to the school or provider. If you have children already in college, this can be an attractive option for you and your parents. Alternatively, your parents can structure a trust for your kids' future use, writing the terms so that you have access to income if you need it.
SENTIMENTAL VALUE. For assets that have appreciated greatly in value, such as real estate, securities, or art, you do exactly the opposite as with cash: Get your parents to leave it in their estate rather than selling and bequeathing you the proceeds. That's because such property is valued at the time of death, so heirs avoid capital-gains tax. Of course, appreciated property gets counted toward the transfer-tax exemption. A house, a few good paintings, and a stock portfolio can easily add up to the $600,000 per-person allowance.
When assets have sentimental as well as monetary value, such as a second home that served as the family summer retreat, emotional questions come up as well as financial ones. Children should tell parents frankly whether or not they want to inherit an interest, particularly if several siblings are geographically scattered or have different living standards. "Splitting everything equally isn't always the most attractive way to do things," says Nager. Weigh, for instance, the benefits of inheriting any property whose upkeep will be expensive, especially if it doesn't earn income.
Legal difficulties need to be anticipated, too. Steven Wohl, a partner at law firm Greenfield, Eisenberg, Stein & Senior in New York, says that in a harmonious family, the best protection against future disputes is open discussion between generations--about every type of inheritance. "People fight over garden equipment more than they do over the big bucks," he says. The more specifically a will is written, including who should get Grandpa Harry's antique clock, the less room there will be for rancor.
In a family where some members don't get along, Wohl says heirs can take defensive action. There are only three grounds for contesting a will: You can invalidate the document by proving that someone exerted undue influence over the writer, that the writer was mentally incompetent at the time of signing, or that the document itself is improperly drafted. If you have reason to think there may be future conflicts over disposal of property, keep records of family visits, phone calls, and medical consultations so you'll have evidence should you find yourself either challenging or being challenged in an estate case.
Charity usually plays a role in estate planning, especially among the rich, and here, too, heirs should pinpoint their goals. In some cases, donations to a particular foundation or school may have been a family tradition. In others, heirs need to decide how much of their wealth they would like to share, and with whom. The Impact Project, a nonprofit organization in Arlington, Mass., helps inheritance recipients with such decisions, as well as counseling them on how the new money fits into their lives. "We combine financial planning with advising people who want to see their money make the world a better place," says co-founder Christopher Mogil. Even heirs to modest bequests, he says, come for guidance on how the extra wealth can do some good.
Just figuring out whether you can afford to change your lifestyle after an inheritance is a serious matter. Many recent heirs buy a bigger house or take a trip around the world because they feel their money worries are over. In fact, they may not have the long-term income stream to support a higher living standard.
It's also unwise to lapse into fiscal irresponsibility before your parents die, simply because you're counting on a windfall to bail you out. What sounds like a big inheritance can vanish quickly--whether in a stock-market plunge or in medical bills. To neglect your own retirement saving or assume that your parents' money will educate your children is akin to placing an enormous bet.
On the surface, inheriting money may seem a 100% good thing. But horror stories abound to underscore the importance of doing things right. Rick Taylor, a partner at KPMG Peat Marwick in Washington, D.C., cites the misery of a client who inherited the family's lucrative lumber company. In time, he sold the business and wanted to develop its land. Turns out the parents had used a chemical for weatherproofing wood that turned the land into a Superfund site. The resulting liabilities will wipe out his inheritance--plus every other asset within reach. The moral: Learn all you can about your good fortune, so your parents' generosity doesn't backfire later on.
TIPS FOR FUTURE HEIRS -- If your parents have not broached the subject themselves, tactfully ask them to get you involved in their estate planning. Talk to your siblings, too -- Don't abandon your current program of saving and investing because you're counting on a windfall later -- Get to know the family lawyer, accountant, and money manager. Will you be comfortable working with your parents' advisers? -- Be sure your parents understand the benefits of making cash gifts during their lifetime: Each parent can give up to $10,000 a year per child tax-free -- If you have children, consider putting part of your inheritance in trust as a safeguard for their future DATA: BUSINESS WEEK