Two money-management lessons for heirs: Quantify and qualify

By Homero Carrillo Jr. and Amy Sbrusch

In estate planning and wealth transfer, various financial tools—including trusts and partnerships—are available to help the next generation "test the waters" of sound money management.

At some point, however, the heirs take over and the risk of errors increases. Responsible heirs follow two simple but critical rules of fiscal stewardship: Quantify what you really need to live on, and qualify what a rewarding or comfortable lifestyle means to you.

This is not always as simple as it sounds. Heirs' abilities to understand the responsibilities and pitfalls of wealth vary, depending on their knowledge, interest and preparation. As any parent or key manager will admit confidentially, some family members are ready and others have a long way to go.

A 2014 survey by Merrill Lynch found that 70% of respondents with $5 million or more in investable assets wanted their money to last beyond their lifetime, but only 16% of those respondents correctly pegged the percentage they could actually live on for sustainable wealth. (Most overestimated.) Two common mistakes included overgiving without accountability and confusing wealth discussions with simply talking about dollar amounts.

Discussing dollars and cents is important. However, these conversations require context. What dollar figure does each heir believe he or she needs in order to live a quality and comfortable life? What is considered "fair" treatment of family members who work in the family business and those who don't?

Below we present a scenario involving a family who needed to quantify and qualify their approach to individual inheritance. (The names and situation are fictitious and are used for illustration only.) Note that the situations they faced had the potential to reduce their wealth and raised questions about fair distribution, wealth management competency and philanthropy.

The Dahlagher family

The Dahlagher family made their money in farming and built an agricultural products enterprise that includes a feed distribution company. The business is in the third generation of family ownership. Howard is the retired family patriarch. His brother Arthur (president) and daughter Jordan (vice president) are running the company. Most family members do not work full-time in the business, while some have transitioned in and out.

Let's examine how the individual goals of three next-generation family members affect the family business and the family's wealth.

Carla: The aspiring entrepreneur. Carla, a recent college graduate, is Arthur's youngest daughter. She wants to run her own business, financed initially by family money. She has worked in the family business off and on but doesn't have an interest in it as a potential career.

Carla won't have access to her trust until she is 35, but she would like to open a restaurant and has requested startup funds from Arthur. Carla hasn't had to worry about money and is used to asking for it when she needs it. She has a business plan and has set her sights on leasing a building in a trendy part of the city. She has also discussed partnering with a chef.

Because Carla is unproven as an entrepreneur, it is not likely that family members want to put their personal money or the family business at risk. One option is to discuss the possibility of a loan from Carla's trust. If the business thrives, she can pay the money back and begin to earn an income from the business until her trust matures. If the business fails, she will effectively receive a smaller inheritance with low risk to the family wealth.

In the meantime, Carla will recognize that she has a finite amount of money that she could lose if the business fails. She will also realize that she is in charge of sustaining and building her own personal wealth for her lifetime. As a young person, she may not have previously considered the long-term impact of risking her wealth. This request presents a perfect opportunity for Arthur to talk with her about her life goals and the variety of ways to build wealth with less risk. What does she believe is "enough" to live on, now and later? Arthur can let her know that she will always get family support, but financial support is not guaranteed forever.

Jordan: The vice president. Jordan, married with one child, is Howard's daughter. She has worked in the family business since graduating from college. She also assists with decisions regarding the management of her father's and uncle's personal finances and investments through a family office. She has a strong interest in preserving the family wealth for the next generation, but she also wants to leave a legacy.

Jordan's idea of a fulfilling life involves traveling and helping needy communities around the world. She anticipates working part-time and hiring a non-family CEO when Arthur retires. She also wants to set up a private foundation, but she hasn't convinced the family to take action.

Many members of wealthy families want to support worthy causes. It is OK for individual family members' philanthropic goals to differ, as long as there is some agreement on which causes the family business will support. Establishing an annual budget and clarifying giving categories can keep family members inside and outside the business on the same page. This will also help the business manage requests from community or charitable organizations.

There are pros and cons to starting a private foundation that should be considered. As an alternative, donor-advised funds for specific causes or charities require less administration while still offering tax benefits and the rewards that philanthropic activity brings.

Jordan's plan to hire a CEO to enable her to pursue her personal passions also needs careful consideration. Currently, she receives a salary and benefits from the business. If she cuts back to a part-time position, her pay will be reduced—and so will her influence on business decisions.

It is in Jordan's and the family's best interests to have discussions about succession before Arthur nears retirement. She may be able to maintain her full-time position while also taking breaks to pursue her volunteer activities—and gradually transition into retirement with a comfortable nest egg for herself and her family.

Jon: The doctor. Jon is Howard's son and Jordan's brother. He has a specialty medical practice in an affluent area. He has some personal ongoing expenses from a recent ID theft, a divorce settlement and shared custody of his three children. Although Jon earns an income outside the family business, he believes he should have a share of the family wealth. Currently, he is a shareholder in the business and receives an annual profit-sharing dividend. He thinks the amount of his dividend will increase.

As a busy doctor, Jon experiences a lot of stress. He has a vacation home but wants to purchase a second vacation home in the Caribbean that he can escape to and rent out when he's not there.

Although Jon worked in the family business in the past, he isn't contributing to its success going forward. The family must discuss the difference between compensation and bonuses (for family members who work in the business) and dividends (for all owners, whether they work in the business or not). Determining a value for the business today may help calculate each family member's fair share. Those figures can be brought to the board for a vote.

Whether an individual family member should benefit from the company's future growth may be decided on a case-by-case basis. By the same token, the way ownership is divided determines the risk each family member would face should the business profits shrink.

Jon has a right to use his money however he chooses, but he must understand that his dividend from the business is based on the company's continued profitability and is not guaranteed. Can he afford the lifestyle he wants (and be able to pay his debts) on just his salary? The second vacation home may have to wait in light of those considerations until some of his debt is paid off. He also has his retirement and children's futures to think about. He needs to get his estate planning in order, as well; after all, he might get married again.

Start your planning now

Each person has his or her own understanding of what a comfortable lifestyle entails. That's why the family and their advisers must review the numbers in terms of liquid and illiquid assets, tax impact, risk management and charitable giving. Each individual heir's life expectancy and goals should be considered. Your advisers can help you devise the best solutions for your family members, your business and your family legacy.

The senior generation shouldn't just assume that their children will make sound spending decisions. A family wealth education program can teach heirs how to preserve family wealth into the next generation and beyond. It is best to have a series of discussions over time (months or years leading up to the generational transfer of wealth) so that heirs are informed as well as comfortable with the plan.

Sometimes major life or business transitions can prompt these discussions. With change can come strong emotions. Try to look for areas of shared values and goals within the big picture of preserving family wealth.

Homero Carrillo Jr., CPA manages the family office and tax practice at Weinstein Spira (www.weinsteinspira.com), where his clients are entrepreneurs and high-net-worth individuals. Amy Sbrusch, CPA, serves the real estate and business interests of her clients at Weinstein Spira.

Copyright 2016 by Family Business Magazine. This article may not be posted online or reproduced in any form, including photocopy, without permission from the publisher. For reprint information, contact bwenger@familybusinessmagazine.com.