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Nagging ‘NextGen’ Problem: Protecting the Inheritance

Nagging ‘NextGen’ Problem: Protecting the Inheritance

That nagging “NextGen” problem just won’t go away.

In addition to wealth managers’ concerns about retaining the children of their clients as customers, evidence continues to pile up that parents remain highly concerned that their children won’t even be able to hold on to their inheritance in the first place.

Nearly a quarter of high-net-worth individuals in the U.S. with at least $1.5 million in investable assets don’t trust their children or step-children to protect their inheritance, according to a survey released by Barclays Wealth last week. This follows a report earlier in the year by U.S. Trust that found that only one-third of high and ultra-high-net-worth parents surveyed agreed “strongly” that their children will be able to handle their inheritance.

Inter-generational wealth transfer now means “an increasing complexity of choice” that can “result in concerns about trust or even intra-familial conflict,” said Chris Johnson, director, wealth advisory for Barclays Wealth, which issued the study, “The Transfer of Trust: Wealth and Succession in a Changing World.”

But these concerns are not insurmountable, say Johnson and other wealth managers and experts who work with wealthy families. Indeed, these observers say, mistakes can be avoided by increased communication; carefully-prepared trusts, possibly using “incentive clauses;” scrupulous family governance and philanthropy.

“The biggest mistake parents can make is doing nothing, and not communicating their estate plans,” said Jayne Pearl, co-author with Richard Morris of “Kids, Wealth and Consequences.” (Wiley) “Parents often don’t realize how uncomfortable it is for children to ask them about money. Not being able to talk openly is especially hard on Baby Boomers who may be part of a ‘sandwich generation’ and have parents who are still alive. If they don’t know what they’ll be inheriting, they can’t plan for their own children. It’s been said, and I think it’s true, that the greatest gift you can give your children is not the money, but the information they need to know about the money.”

Wealth Transfer As Process, Not Event

Treating wealth transfer as an event and not a process is another common mistake wealthy families make, said Dennis Jaffe, professor of organizational systems at Saybrook University in San Francisco and author of “Stewardship In Your Family Enterprise” (Pioneer Imprint).

“Successfully transferring wealth and responsibility doesn’t begin on a date set by the trust or the first day the next generation goes to work, but should be a gradual process of integration,” Jaffe said. “Wealth transfer should provide for a lot of opportunities for children to demonstrate their competence and skill.”

Strong-willed parents who created the family’s wealth can also be problematic, according to Lisa Gray, managing member of Richmond, Va.-based Graymatter Strategies, consultants on family wealth perspectives.

“The mindset that built the wealth and is used to being the leadership generation has to change,” Gray said. “There is a common delusion that they have control over the next generation, but really the best they can do is influence it. And if you’re able to empower the next generation by passing on your values, you’re actually much more effective.”

One technique that Gray uses is to facilitate separate meetings for generations within a family. “We want to create a safe space for discussion,” she said, “and create a level of understanding to see how the other generation views things. The main thing we fear are things we don’t know or understand, and these meetings can create common ground to build on.”

Trusts, of course, are a concrete manifestation of how wealth will actually be transferred and distributed. But while well-intentioned, trusts are often too rigidly constructed, said Andrew Auchincloss, a director at Bernstein Global Wealth Management. “We see trusts that are not flexible enough for unforeseen circumstances,” Auchincloss said. “They are insufficient to anticipate all the directions events can lead to, so it’s important to make the terms as flexible as possible.”

‘Incentive Clauses:” Pro and Con

So-called “incentive clauses” in trusts are one example of how wealthy individuals who are concerned about how their children will handle inherited wealth are managing distributions, according to the Barclays survey.

One Barclay’s client worried that his child would receive such a large sum of money that the child would not be incentivized to work, according to Johnson. “The clause included in his trust stated that the trust should match, in the form of distributions, the income the child makes through his form of employment,” he said.

But incentive clauses shouldn’t be seen as a cure-all for wealth transfer concerns, experts said.
“They have to be clear, objective and understandable,” Jaffe said. “People show maturity in different ways, and incentive clauses can be misused. It’s important to remember they regulate inheritance, not capability and create rules, not outcomes.”

Bernstein’s Auchincloss was even more skeptical. In his own experience as an attorney and as a wealth manager, he said he rarely saw incentive clauses that worked effectively. Indeed, incentive clauses tend to be “counter-productive,” because “they draw a line in the sand that a child or beneficiary can’t seem to resist crossing,” he maintained.

Effective Wealth Transfer Tools: Governance and Philanthropy

The role of family governance through family councils and family offices were seen as a more effective way to pass on family values and positively influence inter-generational wealth transfer.

While critical, family governance needs to be delineated among the family business, a family office or equivalent and the family itself, Gray said. “Governance shouldn’t be viewed as all-encompassing,” she cautioned. “The family council, for example, can set the parameters for the goals and objectives of all the other governance systems. We’ve found that if the governance systems are viewed as separate systems, it makes it easier for the family to have a conversation.”

Philanthropy was also viewed as an extremely positive influence on wealth transfer.

“Philanthropy is hugely helpful in so many ways,” said Pearl, who also conducts financial parenting workshops. “It’s a wonderful way to get involved in meaningful issues outside your own needs, it allows the next generation to learn how to evaluate companies and invest in charitable funds and it gives the family common ground to make decisions and work together.”

Jaffe, who frequently lectures on family issues and leads workshops for families and family advisors, pointed out that philanthropy also allows children to demonstrate competence and leadership outside the family and can boost their self-confidence by providing a vehicle to demonstrate they can do “something better than their parents.”

But Auchincloss cautioned that philanthropy needs have “a carefully defined charitable mission” to work effectively as a wealth transfer tool. “The effectiveness of the charity depends on the strength of its mission as a living principle for the family,” he said, “as opposed to a fund for satisfying diverse annual giving of various family members.”

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