Intergenerational wealth transfer is an important part of financial advisors’ work but not typically frequent. However, that’s starting to change. Aging generations are leaving more to their heirs, meaning managing inheritance investments effectively is more critical than ever.
Nearly two-thirds of U.S. households are either actively involved in passing on wealth or plan to be. Over the next 20 years, these households will transfer more than $17 trillion. That’s a considerable increase over the past few generations, so these transfers will carry unprecedented weight. Here’s how you can ensure your clients get all they can from their inheritance.
Review the Inheritance in Depth
The first step to maximizing an inheritance investment is to quantify your client’s new wealth. You want to know what kinds of assets they’re inheriting and the specific value of each one so you can offer the most informed advice.
Your client likely understands the value of their inherited cash, but they may also inherit property. They’re less likely to know the full worth of these assets. Consequently, compiling a list of what your client receives and a general range for each asset’s worth is best.
Remember that for some assets, the value will undoubtedly change over time. Real estate is a prime example, and family businesses last longer than typical companies on average, leaving more room for growth — or the opposite.
Look at All Applicable Taxes
Next, you’ll want to manage your client’s expectations by reviewing the taxes. Understanding these is crucial because inheritance taxes can be complicated, and failure to account for them could leave your client in a dire financial situation.
Most states don’t consider inheritance as taxable income, but six states impose inheritance taxes, each with varying rates. If your client lives or does business in Iowa, Kentucky, Maryland, Nebraska, New Jersey or Pennsylvania, find and review these taxes with them. Taxes can significantly lower how much money your client can actually invest.
Even outside these six states, taxes restrict what your clients can do with their inheritances. Liquidating several large assets simultaneously will likely yield high capital gains taxes. Additional penalties may apply to certain behaviors with other assets, too, especially things like real estate or stocks, so it’s essential to review your client’s specific tax standing.
Go Over Your Client’s Needs and Goals
At this stage, you should understand your client’s inheritance, how much of it they can invest and when they can. With those restrictions in mind, you can review their goals to form a sound investment strategy.
If you’ve already discussed short-, medium- and long-term goals with your client, start there. Consider how their new financial situation may affect them. Thanks to their inheritance, they may be more risk-tolerant, letting you turn a once-long-term goal into a medium- or short-term one. Alternatively, you could restructure their long-term strategies to reap more rewards from investing their inheritance over an extended period.
If you haven’t gone over these details with the client before, start by asking them about what they need financially. After addressing how their new wealth can address immediate needs, think of some longer-term investment goals it can help with.
Prioritize Debts
Regardless of your client’s specific situation, it’s best to prioritize paying off debts at this stage. Paying down debt is an essential step in any financial goal, and many Americans have high levels of debt that may stop them from being able to pursue other investments. Addressing this will free up more room to meet other, more exciting goals.
Your client likely has at least some debts they can pay off or pay down with their inheritance. Mortgages, student loans, credit card bills and car payments are all fairly common. While paying these loans off may not be the first thing that comes to your client’s mind, it’s the best way forward.
Explain to your client how paying down debt will free more capital long-term to focus on other financial goals. If they have multiple debts, start with the largest one, then move to the next if there’s still money left over after paying the first.
Stay on Track
Once you start pursuing your client’s other goals, remember that their priorities, financial situation and the worth of their inherited assets will change. In light of these shifts, reviewing their goals and strategies regularly is crucial.
Meet with your client at least every few months to review everything again. They may have made more payments on their debts or reconsidered some goals. Similarly, some inherited assets they’ve held onto may have appreciated, and they’re ready to liquidate.
Keeping a close eye on these changes will inform the best strategic decisions. You can then ensure you help your client meet their financial goals as effectively as possible.
Inheritances Pose Unique Challenges and Opportunities
Investing an inheritance provides a unique opportunity for you and your clients. However, it also comes with some challenges that may not be obvious at first. Understanding how to manage these situations before they happen is key to maximizing their returns.
Inheritances are becoming increasingly common, so it’s time to start preparing. If you follow these steps and learn the ins and outs of investing this wealth, you can help clients see a return from investing their inherited wealth.
Related: Navigating Market Volatility: Strategies for Advising Successful Long-Term Investing