Why inheritance is not a retirement plan

Of all the financial planning tips your parents gave you growing up, waiting on an inheritance to fund your own retirement probably wasn’t one of them.

It’s not that parents don’t want to pass on wealth to their children, someday, but counting on that money is a poor financial strategy for a number of reasons.

Parents may wind up spending all of their money, especially considering Canadians are living longer. The average life expectancy is 82 for Canadians today compared to 77 in 1990, according to the World Health Organization. What’s more, health care is getting increasingly expensive, especially for someone who has to move into a long-term care facility, and varies widely depending on what province you live. In Ontario, the monthly cost of a private room is C$2,535, according to the Government of Ontario, while the 2016 maximum monthly price for a for a long term care facility in British Columbia is $3,198, according to the Government of British Columbia.

Market fluctuations can also eat into a retirement portfolio. With interest rates still hovering around record lows, more investors — including traditionally cautious seniors — are putting at least some of their capital into equities instead of more conservative, interest-bearing vehicles like Guaranteed Investment Certificates (GICs), hoping for greater returns over a longer period of time. But volatility in equity markets is a variable investors can’t control and should be mindful of. Consider this: The S&P/TSX Composite Index fell about 30 percent between January 2008 and January 2009, when the global recession was at its worst, but was up 50 percent from January 2009 to May 2016. 

What’s more, Mom and Dad may decide to give away all or part of their money to philanthropic causes. It’s what billionaire investor Warren Buffett intends to do, famously stating “a very rich person should leave his kids enough to do anything but not enough to do nothing.”

Or, parents may simply decide to spend all of their money on themselves; travelling, purchasing a vacation home or just enjoying life, before they need to slow down.

The perils of waiting

For all these reasons, and more, waiting on an inheritance that may never come is not a sound financial strategy. And yet, an Ipsos Reid survey found 35 percent of Canadians are counting on money left behind in a Will to fund their futures. This category of people, known as “waiters”, could be setting themselves up for financial failure.

“There’s peril in waiting,” says Leanne Kaufman, head of RBC Royal Trust, RBC Wealth Management. “You don’t know what that money will need to do between now and the time it turns into an inheritance.”

The mistake many waiters make is assuming how much money they’ll get, if any. There are the competing interests mentioned earlier, as well as other family members, especially given the growing number of blended families in society today. Second or third marriages, and the children that often come with them, can dramatically change the dynamics of an estate.

For instance, if one parent dies, the surviving parent may remarry, and choose to include members of his or her new family in the estate. Or, siblings could remarry and take on children from their new spouse, or choose to have more of their own. This can mean less money for all beneficiaries in a Will or trust structure. Some parents may even choose to remove children or other family members from their Will if there’s been a rift that remains unresolved.

“People assume they know how much there is, which might turn into a harsh reality when the time comes,” Kaufman says. “It may not be as much as you thought it was and you may not be getting all of it.”

Relying on a Will is also a problem if the waiter is financing their current lifestyle with debt, and expecting the eventual inheritance to pay it off. What happens if the money doesn’t come? This is increasingly a concern considering the record debt Canadians are currently carrying. The ratio of household debt to disposable income hit a new high in the fourth quarter of 2015, or 165.4 percent, according to Statistics Canada. That means Canadian households on average held $1.65 in debt for every dollar of disposable income. Being deep in the red also means less money that’s invested for retirement, and a lost opportunity to capitalize on the power of compound returns over many years.

Building incentives into the inheritance

With wealth also comes responsibility and higher expectations, which is why more parents are also setting concrete expectations in their Wills and trust structures before their wealth is transferred, says Tony Maiorino, vice president, Wealth Planning Services at RBC Wealth Management. Parents want kids to earn their inheritance, often in different ways.

For example, a child may not be entitled to their portion of an inheritance unless they finish school, carve out a career path or volunteer a certain number of hours towards an agreed-upon cause.

The idea is to encourage adult children to make the most of their lives, while at the same time giving parents some comfort that they aren’t spoiling their children by simply handing over the funds. Parents are often fearful that sudden wealth will make their kids unmotivated, regardless of how old they are when they receive it.

“A trust is a good strategy that can be put in place to prevent that from happening,” Maiorino says.

Maiorino says about three quarters of his clients are looking to leave at least some part of their estate to either a charity, an educational institution, a hospital or a church. Some are also bypassing their children entirely, and instead leaving money to the grandchildren.

“If you look back 20 or 30 years ago, something like that rarely happened, but it’s more common today,” he says. “Each family is different.”

All of these wealth transfer choices could spell bad news for waiters counting on their parents’ money to take them through their own retirement. A smarter strategy? Don’t wait on something that may never come.