The great wealth transfer: Is your family ready?

The Merrill Perspectives podcast

The great wealth transfer:

Is your family ready?

With:

Chris Hyzy

Chief Investment Officer,

Merrill and Bank of America Private Bank

Jen Galvagna

Head of Trust Solutions,

Bank of America Private Bank

Rocky Fittizzi

Wealth strategies advisor,

Bank of America Private Bank

Please listen to important information at the end of this program. Recorded on 8/17/2022.

Chris Hyzy:                It’s estimated that within the next two decades as much as $84 trillion in wealth could be passed down from today’s older generations to their millennial or generation X children.  (Source: Cerulli Associates, Jan. 2022).

                                    That’s the largest projected amount ever and could certainly be welcome news for many recipients. But how prepared are most families for this “great wealth transfer” as it’s been called? Are there steps parents and their children could take in advance to make the process as smooth and stress free as possible?

                                    Hello and welcome to this edition of the Merrill Perspectives podcast.

                                    I’m Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank. In this episode we’re discussing transferring wealth to the next generation and some of the practical steps families could take now to be prepared.

                                    We’ll look at some of the common drawbacks families can encounter and ways to work through them. We’ll also look at the different ways parents could pass along wealth and some of the potential tax implications their heirs should be aware of.

                                    Joining me for this conversation are Jen Galvagna, head of Trust Solutions, Bank of America Private Bank.

Jen Galvagna:           Hi, Chris. Thanks for having me.

Chris Hyzy:                And Rocky Fittizzi, wealth strategies advisor, Bank of America Private Bank.

Rocky Fittizzi:           Hi, Chris. Great to be here.

Chris Hyzy:                Okay. So let’s start with our first question. The whole idea of discussing wills and passing on wealth isn’t an easy topic, but it’s important on so many levels. What are some of the ways families could approach it and is there an ideal time to start?  Jen, let’s go with you first.

Jen Galvagna:           Thanks, Chris. It’s a good question and there are a number of different points in a child’s life when it’s great to bring up these topics.  As they’re graduating from college, it’s a nice opportunity for parents to start a conversation. As they’re starting their career, they’re thinking about savings, they’re thinking about 401Ks, they’re thinking about investing, it’s a great time to talk about what you’ve done from an estate planning perspective.  And that can be not only the types of planning documents you’re putting in place to take care of your family, but also how you’ve approached investing.

                                    And it's important in a number of ways. One of which is it, it will factor into what they decide to do for themselves as they start to make decisions on careers or on different investments they might want to consider. They'll know what you've done for them and what you've put in place. And I think there's, there's a lot of value in those conversations. 

                                    Let me turn it over to Rocky, because I know you'll have a lot to elaborate on there.

Rocky Fittizzi:           Thank you, Jen. There are typically two rules that I follow when it comes to approaching the wealth transfer conversation with families. The first is that communication is key and that’s communication starting at an early age and continuing out through the course of their lives.

                                    The second is the acknowledgement that every family is different and every family member is different. There’s not really one rule of thumb that works for every family and determining when to start this conversation about wealth can be a real challenge.

                                    But as advisors, we bring up that the consequences of not having those conversations can be extremely damaging to the entire family, whether it’s a lack of estate planning and costing the family millions of dollars in estate taxes. Or even worse, it can cause disharmony and rip a family apart.

                                   So how should a family approach this? I think we go back to that point on communication. So at the earliest age, parents should be thoughtful in their conversation about savings and where mom and dad acquired their money. Discuss with them about what work is and how they acquired their wealth and assets.

                                    Then when they get older and you have full family financial meetings, you start to present aspects of the family wealth, the estate plan, charitable goals. I’ve really found success with that approach, Chris, and getting in front of it very early with clients and their children.

Chris Hyzy:                Now let’s dive a little bit deeper there, Rocky. Once you’ve got the conversation going, what are some of the key questions now that parents and their children should be asking each other?

Rocky Fittizzi:           I think the key questions start and depend on the age and the maturity of the children. I think younger children are going to ask those basic questions, “How much money do we have? Are we rich? What do you do?” While an older child hopefully has the more mature questions about, “What are your plans for retirement someday? What does the potential inheritance mean for me? What’s going to happen to the family business? Am I going to be a part of it?”

                                    As a parent, I think the ideal questions to ask back to their children really are around family values, especially at an early age. “How do you think we acquired our wealth? How does it help us do meaningful things as a family? Have you noticed the causes that are important to us and what we invest not just our money in, but what we invest our time to?”

                                    I’ve had clients over the years ask me how they have this difficult conversation with their children. And I recommend they take a conversation that can easily be very negative when you’re talking about their own death, their own mortality, the concern about the maturity of their children, and then try to have them turn it into a positive conversation about what the wealth has meant for their family and the unique opportunity it’ll provide them in the future.

Chris Hyzy:                So let’s talk about a subject now that, Jen, you and I have talked about quite a bit, which is this concept of complicated family dynamics.  Or at least potentially complicating family dynamics. For example, when there are multiple beneficiaries involved or maybe a family business that the children may or may not want to continue. How could families approach these types of sometimes difficult situations?

Jen Galvagna:           It’s a good question, Chris, and it’s interesting because the word “complicated” can mean a lot of different things. It could mean a blended family, it could mean a second marriage, it could mean kids from a prior marriage and kids from a current marriage. So the more that you can have these conversations in advance on the approach that you’re taking to planning is really critical.

                                    And you bring up a great point regarding assets. You can’t make an assumption that the kids or the beneficiaries would like or would not like a certain asset because to your point, there may be a kid who you’re leaving the family business to who’s really not interested in running the family business. 

                                    Or you may have a beautiful vacation home and guess what? That beneficiary is not able to support that asset. They’re not able to pay all of the expenses around supporting it on an ongoing basis, so it’s not a great asset to leave to that beneficiary. So conversations like that are just absolutely critical as you’re putting together a plan.

                                    You know, Chris, another question that we get a lot is what is the difference between an estate and a trust? The estate is more of a generic term, which refers to anything that you have an interest in, any asset.  So that could be an asset you own in your own name. It could be something you own jointly. But anything of value that you own today is a part of your estate, your overall estate.

A trust is simply one component of an estate.  It's a way to hold your assets, but then be able to make decisions around how those assets will be distributed to your family down the line. And it's a type of vehicle where you have a lot more control over the decision making. So it's simply one component of the whole, but a really important component.

Chris Hyzy:                Let’s go deeper on this part here. So now with the complexity potentially being high, what are some of the mistakes or potential oversights families can make and are there ways to course correct if they are made?

Jen Galvagna:           The biggest mistake is failure to have a plan at all. And believe it or not, families spend a lifetime building wealth and they just don’t get around to putting an estate plan in place. Which is unfortunate because what that means is that the State in which you live will govern the distribution of your assets and that’s a tough situation to be in.

                                    But even more, what we often see is somebody who did put a plan in place and it was a great plan at the time, but they didn’t monitor the plan.  

                                    So for example, life happens and your financial position improves, you have kids, your objectives change and then all of a sudden that plan isn’t working well anymore. 

                                    And it’s unfortunate because things may happen as a result of you not updating your plans, such as assets may wind up with beneficiaries that you didn’t intend for them to receive.  Or it may be that you would have liked to have been a little bit more customized with who was receiving what from your estate, but you didn’t revisit the plan to refresh your memory on what you had done.

                                    A third area that I just would like to visit quickly is also people don’t think about how they’re leaving their assets to their beneficiaries.  And although parents often want to leave assets outright to their kids, they’ll say, “My kids are absolutely responsible. I feel very comfortable with their decision making,” they’re not thinking through what could also occur.  Which is potentially if there’s a divorce, if there’s a creditor issue, if there’s a liability that occurs with that child, those assets could be vulnerable to being lost.

                                    And it’s one of the reasons we talk a lot about trusts with families because again, it’s a way for you to leave assets equally to your family, but also have some type of control over how they receive the assets and for what reasons and that adds a layer of protection that leaving the outright distribution just doesn’t add.

Chris Hyzy:                So that brings me to a major decision, Rocky, that many parents are making today, and that is the option or at least the thought of giving a portion of their inheritance while they’re still living. Are there advantages or possible drawbacks to this approach?

Rocky Fittizzi:           Absolutely, Chris, and I look at this both from a financial perspective and a personal perspective. First, for larger estates, we sit in a unique time where the Federal Estate and Gift Tax exemption are sitting at over $12 million per individual and $24 million for a married couple. Those high amounts are set to expire or sunset in 2026, unless legislation in the next couple of years changes that and we certainly can’t be sure of that and know what’s going to happen in Washington in the next couple years. 

                                    But for very high net worth clients, large gifts make a lot of sense now because the exemption could get essentially cut in half in 2026.

                                    But from a personal perspective, whether you’re flirting with the estate tax or not, I think a lot of parents simply just like to see their children or grandchildren enjoy the benefits of their gifts at lifetime. So family vacations, or paying off a mortgage, paying for college. These are really neat things for parents to experience with the money they’ve worked so hard to accumulate over the years.

                                    So the positives of gifting is minimizing taxes, potentially, during their lifetime and at death - and also seeing the personal enjoyment of the gifts to their loved ones.

                                    Now, the potential drawbacks are maybe gifting too much away, running out of money.  That’s why we run cash flow analysis for our clients and dig into the details about their living expenses and their income and their asset base to see what they can afford to give away while still maintaining their lifestyle. 

Chris Hyzy:                So Rocky, after you receive an inheritance, once a recipient receives this, there’s also the question of potential tax consequences. You touched on this a little bit, but what are some of the most important considerations to be aware of here. And let’s talk about the different types of assets that could be involved.

Rocky Fittizzi:           For tax purposes, inheritances are income tax free to the children with very few exceptions and the main one being pre-tax retirement accounts, so 401Ks and traditional IRAs that haven’t been taxed before. So we’ll come back to that pre-tax retirement account in the minute.  

                                    But I want to focus on the three main assets that a majority of our clients and individuals have. That’s cash and potentially brokerage accounts, that’s a house or a piece of real estate, and then we’ll get to that 401K or traditional pre-tax IRA.

                                    So first of those, cash accounts, brokerage accounts, no tax implications on the inheritance, but when you inherit a brokerage account, you receive a tax benefit called the Step Up in Basis. That’s where the assets receive a new cost value that’s equal to the value of the decedent’s date of death.

                                    Now with older clients who’ve held assets and been in the market for years, that can be a substantial change to the basis and save a lot in future capital gains taxes.  But upon receiving the inheritance, the brokerage account belongs to that beneficiary so future taxes associated with the account going forward are theirs.

                                    Second, to the house and real estate. They also benefit from that same Step Up in Basis rule. Important to note though for a younger individual receiving a house, that new owner then acquires the real estate taxes, school taxes, sewer and all of those joys of maintenance in home ownership that come with it.

                                    And the third one is to go back to that 401K or traditional IRA. These are the pre-tax retirement accounts, which means income taxes have never been paid on them.  So the beneficiaries are required now to withdraw them over a short 10-year period and pay taxes at their own personal tax rate.  So we always caution individuals to know that this isn’t coming to them tax free without responsibility to take required minimum distributions.

                                    Now, there’s other assets, larger assets -- family businesses, commercial real estate, other items which should be discussed with the family’s advisors and CPA because they take on a different level of complexity.  But I’ve found, Chris, those are the main three that a lot of individuals should know about as they go forward with an inheritance.

Chris Hyzy:                So from that perspective, Rocky, should the recipient think about reassessing their own financial goals and the role an inheritance could play now and in the future?

Rocky Fittizzi:           100%, Chris. We always recommend that all individuals review and update their financial and estate plans any time that their personal or financial situations change. In this case, you have children or recipients that are finding out they’re going to be inheriting a potentially significant amount of money and complex assets in different structures.

                                    One follow-up I have is when clients are discussing the estate plan and the inheritance is the recommendation that they really entrench them in with the family’s advisors.  And it’s a nice way to also continue to raise responsible kids by introducing them to their advisors and continuing them along this great path that you started for them.

Chris Hyzy:                So Jen, what type of team is it important to have to help guide through this process?

Jen Galvagna:           I think the team can be looked at in a number of different ways and it really depends on the family.  And that could be a trust professional, an investment professional, it could be different advisors that can provide all types of services. But I also like to include the outside advisors, so whether it’s the CPA or the attorney. The more we can work together to provide holistic advising, the better off the family is the end of the day.

Chris Hyzy:                We already talked about at the outset the potential for $84 trillion to be passed on over the next two decades or so. What are some of the broader implications of all of this for future generations? Rocky, let’s start with you first.

Rocky Fittizzi:           This level of wealth transfer is a very unique, but hopefully exciting opportunity for the next generation. It can provide them with financial flexibility to pursue passions of theirs, to not stress about how they’re going to pay for their children’s education or mortgage.  It can also provide them with an opportunity to continue the values and legacies that their parents set forth for them and pass those same family values on to the next generation coming behind them.

Chris Hyzy:                Jen, how do you view it?

Jen Galvagna:           We look at it as an opportunity for us, this enormous transfer of wealth to work more with families on a granular level and get to know the future generations.  And what I like is being involved with families over many, many years. It really is rewarding to be a part of these, the intergenerational transfers in these families.

Chris Hyzy:                That’s a great way to close the conversation today. Jen, Rocky, thanks so much for joining me today.

Jen Galvagna:           Thank you.

Rocky Fittizzi:           Thank you, Chris.

Chris Hyzy:                And thank you all for tuning into this edition of the Merrill Perspectives podcast. My guests have been Jen Galvagna, head of Trust Solutions for Bank of America Private Bank, and Rocky Fittizzi, wealth strategies advisor for Bank of America Private Bank.

                                    I’m Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank.

                                    To learn more about our latest insights on the markets, please visit ml.com.  And you can sign up for Merrill Perspectives wherever you get your podcasts.

                                    Thanks again for listening.

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