By Alvina Lo and Stephanie Luedke
For that past several years there has been much discussion across the wealth management industry about the massive transfer of wealth that is anticipated over the next few decades. In fact, recent research published in The Cerulli Report states that an estimated $70 trillion will transfer to the next generation over the next 25 years. Yet, with all of the discussions taking place, there does not seem to be much progress being made toward retaining and attracting the money in motion so far, as evidenced by the 53% of clients who leave a wealth manager after inheriting assets. This article is meant to bring attention to a few aspects of wealth management that we believe, with more focus and a deeper understanding of changing preferences of next-gen clients, can be transformative to the ability to attract and retain the next generation of wealth management clients.
Let’s start by defining the next generation of clients. Given the average age and demographic of wealth management clients in the U.S. today, the next generation of clients includes surviving spouses who are typically female Baby Boomers in their fifties to early seventies, Gen Xers who are in their late thirties to early fifties, and older Millennials who are now in their thirties. This is a broad variety of clients who have a wide range of preferences but some important similarities. Notably, many of the trends and changing preferences across these demographics have been significantly accelerated during the COVID-19 pandemic.
We believe that successful firms will make this a priority, despite the approximately 37% of advisers that are expected to retire over the next 10 years, and will adapt to changing preferences across all aspects of wealth management including planning, and advice, investment management and client engagement. Fortunately, the fundamentals of the business do not need to change. This is about making the next generation a priority and figuring out how to connect, engage and develop relationships on their terms and with an understanding for their priorities and preferences.
At the core of many successful multigenerational families are three things: Structure, Assets, and People. The connectivity between these three pillars is Planning — how can a family integrate all three in one cohesive, well-thought-out multigenerational plan? The advisers who understand all three pillars and can successfully connect them have the best chance of retaining the relationship over the next generations. In fact, our experience has shown that the adviser who can demonstrate to the client that they need all three pillars is often the one who gets invited back to the table. To win the business, that adviser needs to further show that he/she is the one who can orchestrate and integrate all three together. Therefore, it is important to understand at least the basis of each of these three pillars that are “typical” for multigenerational wealth.
How the family’s wealth is structured to sustain for multiple generations is one of the most important considerations. Using trusts for long-term planning has many benefits including tax efficiencies, asset protection and control. One trust that is particularly advantageous is the dynasty trust. This type of trust is an irrevocable trust with the ability to stay in effect for multiple generations. Because future growth of the trust’s assets is not subject to estate, gift, or generation-skipping transfer (GST) taxes, the trust can in effect become a “family fund” for future generations.
A dynasty trust can be established as a “sprinkle” trust, which means that the funds held in the trust may be distributed or “sprinkled” to the beneficiaries as needed. The undistributed funds then grow free of wealth transfer taxes for the next generation and beyond. If the dynasty trust is a “grantor trust” for federal income tax purposes, the grantor pays the trust’s federal income taxes, allowing the trust to grow income-tax-free as well. The provisions of the dynasty trust can be drafted to help provide for the beneficiaries while discouraging them from becoming too dependent on the trust for support, and it can also be drafted flexibly to permit the trustee to make distribution decisions.
Another type of entity that families use to structure their wealth for long-term planning is a family limited partnership (FLP). An FLP can be structured so that it is controlled by members of a family and can consist of two types of partners: general and limited. General partners control all or substantially all of management and investment decisions and bear the liability. Limited partners have limited participation in the management of the FLP and have limited liability. The partnership itself isn’t taxable — rather, the owners of a partnership report the partnership’s income and deductions on their personal tax returns, in proportion to their interests.
In an FLP, generally, the senior family members (parents or grandparents) contribute assets in exchange for a small general partner interest and a large limited partner interest. They can then gift all or a portion of the limited partner interest to their children and grandchildren. This interest can go to the next generation directly or be set aside in a trust. For the most part, gone are the days where structures are done in a black-box with no ability to change. Model trust law and drafting have evolved to permit changes (within certain boundaries) and flexibility to otherwise irrevocable structures. Increasingly, the number one desire for many clients is the need for flexibility should things change in the future. This pandemic has brought home even further the message that anything can happen, and the structure one puts in place today needs to be flexible enough to handle the unknowns of the future.
In the next article in this series, we will evaluate asset allocation strategies for next-gen clients.
Alvina Lo is Chief Wealth Strategist, Senior Vice President at Wilmington Trust and Stephanie Luedke is head of Private Wealth Management at Neuberger Berman.
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