Inter-Generational Wealth Transfer

“A good man leaves an inheritance to his children’s children ….” (Proverbs 13:22 New American Standard Bible)

“Another way to portray differences between middle-class households and the rich is to compute the share of total assets of different types held by each group… In 1998 the richest one percent of [US] households held half of all outstanding stock, financial securities, and trust equity, two-thirds of business equity, and 36 percent of investment real estate. The top 10 percent of families as a group accounted for about 90 percent of stock shares, bonds, trusts, and business equity, and about three-quarters of non-home real estate.” (Palma Joy Strand)

“….the inheritance rules apply equally to all, regardless of privilege. But, like laws defining and protecting property, rules of inheritance differentially benefit the privileged and not the vast majority who stand to inherit little or nothing….Inheritance systems are a major mechanism for the inter-generational transmission of privilege and, as such, constitute a central component of systems of stratification.” (Stephen McNamee and Robert Miller)

“Rules of inheritance and succession are, in a way, the genetic code of a society. They guarantee that the next generation will, more or less, have the same structure as the one that preceded it.” (Lawrence Friedman)

“Family inheritance is more encompassing than money passed at death, because for young adults, it often includes paying for college, substantial down-payment assistance in buying a first home, and other continuing parental financial assistance. Consequently, it is virtually impossible for …[disadvantaged folks – insert middle class folks without family personal equity], to earn their way to equal wealth through wages.” (Thomas M. Shapiro)

“…..while wealthier households receive proportionately more inheritances and in greater amounts, those inheritances account for less of the total wealth of the receiving household than of more modest households, which receive proportionately fewer and more modest inheritances.” (Palma Joy Strand)

“… inheritances frequently amount to, what I call, transformative assets. This involves the capacity of unearned, inherited wealth to lift a family economically and socially beyond where their own achievements, jobs, and earnings would place them. These head-start assets set up different starting lines, establish different rules for success, fix different rewards for accomplishments, and ultimately perpetuate inequality.” (Thomas M. Shapiro)

The world is not a fair place – starting lines are not the same for everyone, even if they all graduate from Harvard Business School on the same day with identical grades. While it is a good idea to work on fixing the problem of inequality, it is best to borrow an idea from the aviation industry – as part of air safety measures, flight cabin crew advise that when there is loss of cabin pressure in the airplane, and oxygen masks drop down, if you have a child, fix your oxygen mask first before helping your child. Why? If you don’t personally secure your oxygen supply, the two of you (parent and child) would be at risk. Fixing the problem of wealth inequality starts with YOU! You need to do all in your power to ensure that you (and your family) get your fair share within the limits of the rules in place – that would position you to help others less privileged and/or informed.

For the wealthy few, planning for inter-generational wealth transfers starts at birth – they carefully examine all options for maximizing wealth accumulation for their offspring; the typical MCF (middle class folk) tends to focus on maximizing wage-earning opportunities for their offspring. So if we consider 2 kids born today, one to a wealthy family (let’s name her Janice) and the other to a middle class family (let’s name her Janet). By the time they both are twenty one years old in 2031, it is not unlikely that Janice may have a net worth in excess of $1 Million for example while Janet has essentially zero (or negative  – think student loans) net worth. It is not unlikely that Janet’s parents would have saved some funds for college which would have been used up for her tertiary education – she may even have had to borrow more by way of student loans. Are we suggesting that Janet’s parents could have done something different to prevent her from being in the zero (or negative) net worth situation? Yes.

An annual commitment of $1,000 to Janet’s wealth accumulation plan, using the right vehicles could put Janet in a position where she has a net worth (personal equity) of $100,000 – $200,000 (based on annual return of 8% – 12% with dividends increasing 10% per year and reinvested – no provision is made for taxes because the total income per year does not exceed the tax exemption threshold in any year) throwing off annual cash payments of $13,000+ – $34,000+.

Where would Janet’s parents get $1,000 per year? Depends on a host of factors – if they can envision the negative consequences, limitations, constraints and frustrations associated with Janet’s future in a zero personal equity scenario, they may decide to cut back on some present expenses (skip vacation every other year? eat out less?). Could they possibly afford $100 per year? And leave Janet with $10,000 – $20,000 at age 21? Even though a small amount, it is still better than zero – which is what many MCFs provide for their children.

Let us further explore an option open only to high net worth individuals and/or business owners – asset based insurance lending using some examples based in the United States. Consider the scenarios  laid out on page 3 of this webpage along with the scenario in this case study. You may notice that all the examples refer to high net worth individuals – no one is likely to propose these schemes to the MCFs (MCWB Club members can expect solutions like this and more).

Back to those examples, note that these professionals are proposing a solution that allows these wealthy individuals to create life insurance policies with no cash out of pocket – at the minimum, this allows them to transfer their estate to their heirs without losing any portion to the taxman. Yes, they need to provide collateral (many MCFs also have home equity – sometimes substantial – which could have been used for something similar but more often than not, generational transfers, usually at death, are reduced due to taxes and other costs), but after a certain point (Year 10 in the first example and year 15 in the second), the collateral is no longer necessary. But the asset (life insurance policy) has been created; furthermore, notice in the second example that starting in year 16, the  $20 Million life insurance policy (created with borrowed funds secured by assets – no out of pocket cash) begins to pay $525,000 per year to the beneficiary for the rest of her life and tax-free! Note also that if Carol lived for as long as 42 years after taking out the policy, the death benefit would have gone up from the original $20 Million to $45 Million – for an asset that was created with no out-of-pocket cash!

Now, let’s turn the tables a bit, suppose Janet’s parents had also taken out similar life insurance programs (not for $20 Million – let’s say for $200,000) on similar terms around the time of Janet’s birth. Let’s examine the implications – high probability of no out-of-pocket cash, first year collateral requirement of $7,000 peaking at $15,000 in year 8 and declining to $0 in year 15 (when the bank loan financing the premiums is also paid off), and tax-free cash distribution of $5,250 per year for life, the possibility of the death benefit increasing to $450,000 around the 42 – 45 year mark (of the policy). OK, this assumes that the same policy would be available to MCFs on the same terms as well as rates – maybe the rates are going to be higher and some other parameters different; overall though, you probably agree that the concept is intriguing and deserves further research.

We cannot discuss all the elements of inter-generational wealth transfer on this page – it is a deep and wide subject that varies from country to country. What is pertinent is that time is of the essence (you need to start early), and access to the right vehicles, products as well as options is key – at this point, MCFs have few options. The MCWB Club will change all that – join today and use the Tell-A-Friend button to invite a friend, colleague or family member (because given each MCF’s limited resources, we need a large number of MCFs to bring these opportunities to the middle class).