What You Should Know About Family Wealth

At A Glance

• Substantial family wealth is completely depleted by the third generation 90 percent of the time

• Private family foundations are a great tool to make a difference and involve your loved ones in causes that are near and dear to your heart

• Communication with and education of your heirs are critical to protecting your legacy

Warren Buffett’s granddaughter, Nicole, while on the Oprah Winfrey show, discussed how she had worked as a housekeeper to support being a young artist. She explained how she cleaned another family’s toilets and dirty dishes to make ends meet. Warren Buffett believes that children born into money are robbed of their experience, which is why he will only fund their education and philanthropic pursuits.

America’s richest families don’t seem to agree with Buffett’s beliefs. According to recent surveys, 80 percent of people with substantial wealth will leave their fortunes to their children and grandchildren. More than half the surveyed said their heirs can do whatever they wish with the money.

Here is where it gets sticky. Based on the research, 60 percent of inherited substantial wealth is burned through by the second generation, and by the third generation 90 percent of family fortunes are gone! Furthermore, 90 percent of estate plans eventually fail.

In many cases the next generation has no idea what they are going to get, and when they receive their family’s fortune they don’t know how to manage it properly. These beneficiaries can be blindsided by the windfall; other times they are handed trusts and wills loaded with legal mumbo jumbo. The heirs are then forced to divine the wishes and intent of their parents. What follows in many cases is chaos, with money being spent needlessly or siblings fighting among themselves.

So how do you solve the above challenges? We would emphasize continuity, communication and education, years before anything is expected to happen, between parents, offspring and advisers. The who, how and why conversation must take place. When estate plans go sour, as they often do, in many cases it is because the parents haven’t managed the heirs’ expectations and clearly explained what was going to transpire after the matriarch’s demise.

Continuity can be achieved through having your wealth manager coordinating efforts of your lawyers, CPAs, insurance agents and other professionals. Making sure that your heirs are well acquainted with your wealth manager is another crucial step. Family retreats and family vision plans can help make this a pleasant experience, as it should be.

Foundations

Foundations are not purely for families like Bill and Malinda Gates. The main purpose of a private foundation is making grants for funding scientific, educational, cultural, religious or other charitable causes near and dear to your heart.

Although private foundations can be set up for relatively small sums of money, we would likely not recommend them unless you plan on funding yours with $1 million or more.

One caution: The IRS and Congress have cracked down on private-foundation abuses, such as improper allocation of funds and inflated salaries, but with the guidance of an experienced professional team you can avoid these common problems.

When should you consider setting up a foundation? We suggest that the best time is when you have strong motivations of philanthropic and giving desires.

Foundations can be set up for the taxable portion of your estate to avoid estate taxes. Since your heirs would not receive this portion of your estate, being that it would be funding your private foundation, you would need to replace this portion of your estate to your beneficiaries via life insurance. Life insurance proceeds pass along to your beneficiaries free of estate and income taxes.

Trusts, insurance premiums, planning costs, insurability and gift taxes, among other things, need to be considered first. If you agree with Warren Buffett’s belief that money robs the children of their experience, then the life insurance part can be left out.

Family foundations allow you and your family to make a real difference; recently, the Bill and Malinda Gates Foundation announced a $200 million donation to fight polio. By getting your children involved they can learn responsibility, money skills and philanthropy while being compensated for managing the private foundation.

In conclusion, we recommend you communicate your family wealth transfer wishes and educate your children and grandchildren to ensure a legacy beyond the third generation. Foundations are one form of creating a legacy, as well as helping loved ones learn about money and making a difference.

Authors Haitham “Hutch” Ashoo and Christopher Snyder are partners at Pillar Financial Services Inc. in Walnut Creek. Ashoo is founder, president and CEO. Reach them at 925-356-6780.