How Families Can Sustain Wealth Through Multiple Generations by Richard A. Berkowitz, JD, CPA
High-net-worth families who intend to transfer wealth from generation to generation face a harsh reality: 70 percent of family fortunes are destroyed by the second generation, and 90 percent by the third. As the story is often told, the first generation starts with nothing and works hard to create wealth. Subsequent generations either live lavishly or fail to take steps to preserve the family’s riches, too often because they did not receive guidance and training from the prior generation. The first example is regrettable; the second example is preventable with proactive planning. Individuals set examples for their children during their lives. Unless parents communicate an alternate plan, their children will expect to live the same way or better upon their parents’ demise.
Wealth management and estate planning involve much more than growing and protecting one’s assets. They require individuals to thoughtfully consider how they will manage their financial affairs during life and how they wish to distribute their wealth to protect loved ones after death. Estate plans are not static instruments. Rather, they require constant attention, care and updating along with individuals’ life transitions, including marriage, divorce and children, as well as changes in tax laws. Each of these milestones present opportunities for individuals to communicate with their children about their plans.
One of the most damaging threats to wealth preservation is the failure to consider a family’s non-financial assets, including knowledge, values and family relationships. How will individuals protect spouses and heirs? How will individuals prepare heirs to avoid squandering their future fortune? How will the next generations carry on the family business and be trained and trusted to make the right decisions?
Plan and Train Family Members Early
The excitement of starting and building a business should not be overshadowed by the fact the, at some point, the founder(s) will leave the enterprise, hopefully to enjoy the fruits of their labor. Without properly preparing for this exit in the beginning stages of a business’s lifecycle, an entrepreneur’s initial hopes and dreams for the future can be quickly dashed.
An exit strategy is a key component of a comprehensive business and estate plan. It is the entrepreneur’s endgame. It will shape how the business is formed, how it grows, operates and manages its finances. Keeping this aim in sight during the growth stages of a business will help to ensure the owner is prepared to successfully transition out of the business at whatever time he or she chooses.
When an owner intends to pass the business onto family members, a number of business succession issues should be addressed and documented. Are heirs willing and able to take over the family business? Will they need specific training, either on the job or through independent coaching, to help them acquire new skills? At what point can the owner relinquish all control of the entity? Will the owner give up control early enough to be in a position to mentor and allow his/her offspring to develop into a leader and innovator to shepherd the family business to future success?
On a more personal front, a family’s financial patriarch or matriarch should consider the strengths, weaknesses, interests, capabilities and potential for his or her heirs to carry on the management of the family’s finances after he or she is gone. Is a child prepared to handle a financial windfall? Does he or she have a relationship with a trusted accountant, lawyer and/or financial planner who has experience with the family’s unique situation? Has the family member had ample opportunities to learn from the family’s financial leader? Is a family member interested and capable of taking on the responsibility to sustain the wealth of the entire family, or should a third-party trustee be engaged?
Engage in Difficult Conversations
No one wants to talk about the intricate details of finances, death or what will happen after a family member retires or dies. However, by engaging in these conversations during life, first generations can make their wishes known and pass along to future generations the knowledge, values and behaviors that are required to sustain wealth. It can help to ensure that all family members are on the same page and working together toward a shared vision or goal. What legacy does the family’s financial leader wish to leave behind? How important is charitable giving to preserving that legacy? Will adult children need a temporary financial bridge to help them support themselves or will they be permanently financially dependent on the bank of mom and dad?
Relationships between parents and children will play an important role in these difficult conversations. Failure to address these issues early on may lead to years of family discord and destruction of wealth. To facilitate these conversations, families should consider bringing in third-party experts, such as accountants, financial planners or estate planners, who can lend their knowledge and experience to provide family members with a reality check, answer difficult questions, temper emotions and provide an independent assessment of relevant issues and opportunities for preserving wealth and long-term best interests. For example, these experts can develop tax-efficient estate plans, budgets and sustainable spending strategies that can carry the family’s wealth through multiple generations.
Rely on Trusted Estate Planning Tools
There is a fairly comprehensive toolbox of estate planning strategies that families can employ to preserve wealth through multiple generations. This can include the establishment of family offices or family limited partnerships, charitable foundations, 529 college savings plans for minor children, special needs trusts for children with special needs, and a wide variety of different trust instruments to effectuate estate and financial-planning strategies.
In general, trusts provide families with tax-efficient strategies for protecting assets from lawsuits and claims from creditors and divorce settlements while allowing the family patriarch or matriarch to specify how they wish family members to receive and manage inherited assets. This can include the age at which an heir may begin receiving distributions of trust assets, the rate of distributions, conditions for preventing distributions and limitations on an heir’s access to the trust principal. There are many different types of trusts, and the one that is right for one family may not be appropriate for another.
Preserving family wealth for multiple generations requires attention to the finer details of appropriate planning and communication as well as making use of tried and true estate planning tools. An accountant or financial planner is an excellent source to begin this process and provide counsel on ways to avoid losing a family’s financial legacy. Making the decision to establish a generational wealth plan for a family will only succeed if the plan is well conceived, understood and executed by loved ones.
About the Author: Richard A. Berkowitz, JD, CPA, is founder and CEO of Berkowitz Pollack Brant Advisors and Accountants, where he works with individuals, families and entrepreneurs to develop a comprehensive approach to income, estate, investment and business planning to meet the goals and objectives of and to improve the tax consequences for high-net-worth individuals and their families. He can be reached at the CPA firm’s Miami office at 305-379-7000 or via email at firstname.lastname@example.org.