Why the 'Great Wealth Transfer' Could Leave Heirs With Less Retirement Money Than Expected
Boomers hold trillions in wealth, but rising healthcare costs, taxes, and longer lifespans are shrinking inheritances. Here is how to build a retirement plan without relying on a windfall.
Expecting an inheritance and thinking that means you don't have to save for retirement? Think again. You don't know for sure the timing or size of your windfall, or whether you'll receive one at all.
The stock market is at record highs, and baby boomers hold $68 trillion to $84 trillion in wealth they intend to pass down in what is known as the Great Wealth Transfer. But they're also living longer and spending more, which reduces the amount left for heirs.
"It's taking longer before our clients are receiving an inheritance," says Sarah Wotherspoon, managing director at Wealthspire. "The reality is, people don't know how long they will have to wait, and they also don't know how much they will receive."
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In the meantime, boomers are spending their money on luxury travel, longevity products, high-end retirements, healthcare and long-term care, says Wotherspoon.
They're also giving while living, paying for their adult children's homes, grandchildren's colleges and family vacations, she says.
That doesn't mean there won't be money left over if you're in line for an inheritance. It does mean you shouldn't bank on it. Here's what you should do instead.
Don't assume your inheritance amount
You might think you'll get $5 million because your mom and dad said so, but the reality could be vastly different when they pass. Even if the amount is accurate, taxes, legal fees and distributions can change your inheritance outlook.
That's why it's important to have a conversation with your parents and their financial advisers about your inheritance. Without an accurate understanding, it's hard to plan.
You might not need the money and want it passed on to your kids instead. Wotherspoon says she sees this more often.
If you can't find an exact amount, Wotherspoon says to cut your assumption by 50% or 60% and plan based on that. If your inheritance is more, you'll be happy; if it's less, you won't be caught off guard.
Don't treat your inheritance as your retirement plan
Just because you're getting an inheritance doesn't mean you won't need a retirement plan.
Taxes are a big part of estate planning, especially if the inheritance is large enough to push you into a higher income bracket. The goal should be to pay the least amount of taxes on your inheritance, and you can't do that without planning across all the generations that are in line to receive money.
Wotherspoon had one client who saved his money during his lifetime so his son and grandson could receive substantial wealth at his passing. While he was living, he converted a large retirement account into a Roth IRA and took a big tax hit so his heirs could avoid paying taxes later.
His own account might not have enough time to recover from the tax hit, but his son's and grandson's accounts do. "An important part of this is tax planning," says Wotherspoon.
Don't spend an inheritance you don't have yet
You might expect a nice windfall later in life, but that's not permission to spend now and worry later. Don't blow off saving for retirement or accumulate debt just because you know cash is coming someday.
"We have clients who were tempted to make major life decisions because of an inheritance," says Wotherspoon, who advises against that. She has clients who want to buy third homes, retire early, take luxurious trips, and take on home renovations in anticipation of future inheritances.
Before they proceed, Wotherspoon asks them: What would happen if the inheritance were delayed a year, two years, even five years? What would happen if they received less? Could they pay for whatever expense they wanted to incur?
Do build an independent retirement plan
Even if a financial windfall is a sure bet, it's important to build a retirement savings plan independent of it. That way, if things ever fall apart, you will be ok. Your independent retirement plan should include the following steps:
1. Contribute as much as possible to your 401(k), IRA, HSA and any other tax-advantaged retirement savings accounts. If you can't contribute the maximum, try to meet at least the match, if your employer offers it.
2. Run two scenarios for your retirement. One based on your monthly savings, retirement age, income and budget. The other includes about half of what your parents say you will receive as an inheritance. Once you have both numbers, you'll know exactly how much you need to save on your own and how much you can rely on your parents.
Use the zero-inheritance plan to set your mandatory monthly savings goal right now. Then, write out a simple rulebook for the second scenario so you know exactly what to do if money actually arrives later. For instance, you may use it later to pay off your mortgage early or fund your kids' college.
3. Consider hiring a tax professional if you will receive an inherited IRA. Thanks to the SECURE Act, non-spouse heirs have to withdraw all the funds within ten years of receiving the IRA. Additionally, if your parents had already started taking required minimum distributions (RMDs), you may be legally required to take annual withdrawals during years one through nine.
If you don't spread out your withdrawals or if your IRA balance is large enough, it could create sizable tax events. That's why a tax pro or CPA can come in handy when you receive an inheritance. They can help you spread the distributions out, lowering the amount you owe Uncle Sam.
4. Have an open and honest conversation with your family about your inheritance. It doesn't have to be the exact amount down to the penny, but you should discuss the general size of the estate, where all the documents are, and who the executor or trustee is. Confirming that your parents have an up-to-date will or living trust and ensuring account beneficiary designations are current is what prevents assets from getting tied up in costly probate court.
Consider it an enhancement
Nothing in life is a guarantee, which is why your inheritance should be treated as an enhancement.
Plan for the tax consequences of your potential inheritance, but don't assume it will be there. Save as if it doesn't exist. That will prevent you from making any bad decisions that could harm your financial independence and retirement.
"That inheritance has to travel through taxes, the legal process, family dynamics, and market movements," says Brigette Engstrom, CEO of Blue Monarch Financial Services. "The amount can change, the timing can change, the way the assets are distributed can change. You are not ignoring the inheritance; you are refusing to depend on it until it actually becomes available."
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