Growing up in a family of significant wealth can be extraordinary. Splendid vacations, lavish homes, luxury cars and education at the best schools. It can also color your world with unrealistic expectations.
A grandchild in a family of multigenerational wealth, in which, let’s say, the grandparents have a $300 million estate, is likely to be exposed to an opulent lifestyle. The grandparents in this scenario may have multiple homes and cars, and a staff to manage many aspects of their lives, from cooks and chauffeurs to golf pros and attorneys. They may use private jet services, stay in the finest hotels and travel to exotic destinations. And the grandchild’s own parents are likely to live a privileged lifestyle too, although maybe slightly scaled back. Perhaps they own two homes and fly first class more than private jets but are still able to send their children to the schools of their choice, maintain a tony country club membership and take amazing vacations.
The trouble with all of this can be that the grandchildren in this scenario may see and experience all these privileges without a decent understanding of two key principles: taxation and division.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
How Taxation Can Eat Away at Wealth
Estate taxes are always a huge consideration for families of multigenerational wealth, because at the top bracket, the federal government is going to take 40% of the portion of the estate that falls over the estate tax exemption (currently $22.4 million per married couple) when it transfers from the grandparents to the parents. And when the estate transfers from the parents to the grandchildren, another 40% is going to be siphoned off. Then, in states like Pennsylvania, where we operate, there is a state inheritance tax (4.5%), which will be assessed in addition to the federal estate tax each time wealth transfers from one generation to the next.
So, if we were to consider the effect this would have on a $300 million estate in Pennsylvania, transferring from the grandparents to the parents, and then from the parents to the grandchildren, that $300 million could potentially lose over $190 million to taxes in two generations. Of course, there are many strategies you and your adviser can implement to move assets outside of your estate to minimize the impact of estate taxes. The intent here is to demonstrate what would result if no tax planning actions are taken.
What’s Worse: The Problem of Division
Perhaps even more impactful to the third-generation beneficiary than estate taxes is division. Let’s say in our example that the grandparents had three kids, and each of those second-generation kids had three kids of their own. To keeps things simple, assume the benefactors divide everything equally among their children when the assets are transferred to the next generation. This would result in the second-generation kids each receiving roughly $58 million, and the third-generation kids getting roughly $14 million (after estate and inheritance taxes are factored in). This is also assuming there is no loss of principal and that all of the assets go to the children.
If the matriarch and patriarch in the first generation want to leave a significant portion of their assets to a charitable organization, say $100 million off the top, this will have a significant impact on both the second- and third-generation beneficiaries.
The Bottom Line
Regardless of the specifics of the scenario, the central point is that while the third generation may have grown up around the $300 million estate lifestyle of their grandparents, and perhaps gotten used to it, the expectation that they will be able to live that same lifestyle is highly unrealistic. What is essential to prepare the third generation for what will still likely be a substantial inheritance is a straight-forward and honest discussion about the family’s estate planning strategy, philanthropic intentions, and their own role in supporting the family’s vision and legacy.
Transparent communication with the next generation will provide a realistic expectation about what they stand to inherit, as well as clarity about their responsibilities to make sure the transfer of wealth is successful.
When the next generation understands the impact of taxation and division, they will appreciate why there is a seismic shift from their grandparents’ lifestyle to their own. The value of this knowledge is that it illustrates the necessity of structuring their lifestyle in a way that is sustainable, so they will be in a position to transfer the family’s wealth to the fourth generation.
-
Affordability Crisis: Florida Votes to Increase Property Tax BreakState Tax Property taxes have skyrocketed nearly 60% within the last five years in Florida, and its constituents are finally doing something about it.
-
Average Net Worth by Age: How Do You Measure Up?Financial advisors discuss the secrets to growing your net worth over time.
-
Three Charitable Giving Strategies for High-Net-Worth IndividualsIf you have $1 million or more saved for retirement, these charitable giving strategies can help you give efficiently and save on taxes.
-
The Wealth-Building Powers of Health Savings Accounts (HSAs)Health savings accounts could be the most underutilized wealth-building tool out there. Here’s who should use them and how to maximize their benefits.
-
Seven Ways to Be an Absolute Jerk as a LawyerHere's what law students need to know about damaging their relationships with other lawyers and judges and running up the bill for clients.
-
One Good Way to Withdraw Retirement Assets (and a Bad One)Don't withdraw retirement assets haphazardly. Managing distributions intentionally can lower your taxes, conserve your wealth and reduce Medicare premiums.
-
What Is Capital Gains Tax Deferral?Spoiler alert: It's the secret weapon of savvy real estate investors. Here's how it works and details about the tools you need to do it.
-
Don't Leave Your Heirs an IRA Tax BombYour traditional IRA has served you well, but when your heirs inherit it, watch out. Consider some of these strategies to minimize their tax burdens.
-
Five Ways to Maximize Your End-of-Year PhilanthropyTo do the most good, pick the right charity, be smart about how you donate and consider giving something just as valuable as money: your time.
-
Three Options for Retirees with an Old (Forgotten) AnnuityDid you buy an annuity in the 2000s? If it’s been out of sight and out of mind since then, it's time to dust it off and start making it pay for your retirement.
