Inheritance planning: Beating the “shirtsleeves to shirtsleeves” adage

The "shirtsleeves to shirtsleeves in three generations" adage, which describes the inability of grandchildren to manage the wealth passed down to them from their grandparents and parents, has hung over the world's highest net-worth families for decades, threatening the continuation of family legacies. But a new generation is proving they can steward wealth with the right amount of preparedness, education and communication.

While wealth attrition is the most pervasive narrative, families like the Dumas empire, which took Hermès from riding gear for noblemen to a global luxury fashion house, and the Mars family, which still owns the confectionery giant bearing their name, have bucked the historical trend, surpassing that third generation mark with their wealth intact.

In some of those cases, successful wealth transfer is simply a product of the maturity level and innate responsibility of the younger generation.

“Some kids, they're going to be responsible stewards of money – save a little bit, enjoy a little bit and share a little bit," says Dean Deutz, vice president and private wealth consultant at RBC Wealth Management-U.S. in Minneapolis. They will do the right thing, Deutz says, because it's in their nature.

For most other families, successfully skirting the "shirtsleeves to shirtsleeves" trap requires more purposeful planning and education between the generations.

An estimated US$3.2 trillion in assets is expected to transfer from one generation to the next in the United States, according to the 2017 Wealth Transfer Report.

In fact, a third of U.S. respondents have already accumulated their wealth through direct family inheritance, according to The new face of wealth and legacy survey, commissioned by RBC Wealth Management and undertaken by The Economist Intelligence Unit. The study included 1,051 high-net-worth individuals (HNWIs), including 365 in the U.S.

For those families that haven't yet transferred wealth, it all comes down to being proactive and having a plan in place, says Bill Ringham, vice president and director of private wealth strategies at RBC Wealth Management-U.S. in Minneapolis.

Wealth planning is the first step in passing on wealth

Before the conversation shifts to what's next, Deutz says it's important to capture a full understanding of how things look now – do you have a plan in place that will preserve your wealth and carry you through retirement as you envision it?

“If I'm a parent looking at what's next, I need to be comfortable with myself, my situation, and my lifestyle," says Deutz. “Then they can start saying 'I'm good, I can now take the focus away from me and try to help the next generations.'"

Once you have an understanding of how you're going to fund yourself through retirement, you can start to build a picture of how gifting looks while you're alive as well as from an after-death estate planning perspective.

For those who want to begin gifting during their lifetime while still meeting retirement goals, Ringham points to options like the $15,000 gift tax annual exclusion, which can be used to pass wealth to heirs without reducing the donor's lifetime gift tax exemption amount. “There are also estate-freezing techniques, where you're freezing the value of it now and having it continue to grow," he adds.

Sitting down with your advisor to go over your options will help you formulate a plan for passing that wealth to the next generation, and doing so in a way that preserves your legacy going forward.

Educating your heirs on financial responsibility

One of the biggest challenges with inter-generational wealth is a loss of perspective. In the "shirtsleeves to shirtsleeves" adage, the Sandwich Generation is close enough to the initial wealth creation that they still have some understanding of where that money came from. But the third generation often finds itself divorced from the initial wealth creation, and the values surrounding it.

“Some parents recognize their kids are incredibly prudent and will preserve what they've inherited, (continuing) to have a comfortable lifestyle but not necessarily depleting wealth," says Ringham. In other cases, the heirs could benefit from education around what wealth preservation truly means.

From Ringham's perspective, wealth planning presents learning opportunities to sit down with the next generation and talk about the difference between a direct gift to them versus a gift that goes to them in trust. “It could be (putting) as little as $15,000 a year into an investment with their advisor so the advisor has an opportunity to start working with that next generation," he says. “[To show] what it means to invest, what are equities, what is fixed income, etc. – they start to learn the importance of preserving and investing before they even actually inherit it."

And it can be done without money, says Ringham, meaning they don't have to know how much they're receiving, they just understand a structure. “Sometimes the biggest mistake you see is inheriting significant wealth without an understanding of the structure [or having] a team in place for them that has a general understanding to help them transition into that wealth," he adds.

Learning to have the hard conversations on inheritance

Few hurdles carry as much weight as a lack of inter-generational communication.

“Generally speaking, the Greatest Generation is very private and they don't necessarily want to completely open up and share everything with family," says Ringham. “But if the next generation is willing to sit down and hear and listen and understand, it does really alleviate surprise and the likelihood of being unprepared."

For families who struggle to talk about wealth, Deutz says he often uses legacy and discussions around charitable causes as a doorway to the bigger conversations about wealth transfer.

“I've done this with my kids to show it's not only my charities that matter, it's the family's," he says. “If I can give money to something my kids care about, they start to feel the delight and the joy and they give their own money."

It can be something as simple as talking through the causes and values important to each generation. “Saying 'you can give away $10,000, who are you going to give it to and why?' before making distributions out of a donor advised fund or private foundation," says Ringham.

But the younger generations, the inheritors of the wealth, need to step up and ask questions – not because they're interested in the value but because they want to “understand the why," says Ringham.

“Help me understand where those values came from, help me understand that if you are going to create a foundation, what would you like us to do to continue that cause for your benefit or how much of the money is available for us for our causes if they aren't consistent with your causes," he says. “It doesn't really matter if it's $1 million, $10 million or $100 million, that's a fairly consistent conversation."

Sometimes, to help facilitate those difficult discussions, it makes sense to call in a professional — an unbiased third party that can offer a more sweeping viewpoint. For instance, suppose the parents are uncomfortable talking to their children about a prenuptial agreement. “We can explain that most people in this particular situation require children to get a prenuptial agreement – it doesn't necessarily have to come from the parent of the children," Ringham says. “It becomes not an emotional conversation but really an objective conversation on what other people in this situation do."

In a sense, both preparedness and education stem from communication, and it's the ability to be transparent and open with the next generation that can help prevent wealth attrition and preserve the family legacy beyond the shirtsleeves.

“The ideal scenario is every family has an enlightened, open, honest and non-judgmental conversation between the parent and the child and everyone feels better," says Deutz. He acknowledges it doesn't always happen, but the goal is to start the conversation.