Many millennials across Canada will receive an inheritance in the coming years, but managing those assets could turn out to be more challenging than expected.
A recent Toronto-Dominion Bank survey shows that 83 per cent of millennials are confident in their ability to manage an inheritance, yet nearly half (46 per cent) who have received this form of new-found wealth regret not getting some professional advice on how to handle it.
“There’s a perception in terms of their ability, but once they have the inheritance, it has become overwhelming,” says Jeet Dhillon, vice-president and senior portfolio manager at TD Wealth.
For some, the value of the inheritance is more than they expected, making them high-net-worth individuals overnight. “It can be difficult, in the moment, to make strategic decisions that will benefit you and your family for the long term,” she says.
Mistakes people often make with sudden wealth include overspending, taking on riskier investments, or forgetting to account for additional income from inherited investments, such as an income property, which can lead to a higher personal tax bill.
Mismanaging an inheritance could become more of a problem in the near future given estimates that $1-trillion in personal wealth will be transferred from one generation to the next in Canada between 2016 and 2026 — about 70 per cent of that in the form of financial assets, according to a recent survey.
Experts recommend that anyone receiving an inheritance take a step back and assess their short- and long-term financial goals before making any major financial decisions. Here’s some advice on how to better manage an inheritance:
1. Start with the financial fundamentals
Regardless of how much you inherit, Ms. Dhillon urges people to prioritize their spending and investing to ensure the assets have a maximum impact.
For example, instead of buying a boat or cottage, first consider paying off debts, such as a mortgage or car loan, to get rid of interest payments. “This may free up more of the money you earn for the things you enjoy,” Ms. Dhillon says.
Another option for investors is to top up registered retirement savings plans or tax-free savings accounts to take advantage of the immediate and longer-term tax benefits.
“Those are the first places we tend to go,” Simon Tanner, principal financial advisor at Vancouver-based Dynamic Planning Partners, says about working with clients who have just received an inheritance.
2. Make a financial plan (or refresh your existing one)
A sudden influx of wealth is a good time to set up, or redo, a financial plan, which takes into consideration a person’s finances using different variables to predict future cash flows, asset values and withdrawals.
For most people, having a financial plan, regardless of their wealth, helps them to determine how much or how little to spend now and in the future. It can also help people to figure out when they can retire, or at least semi-retire.
“It’s about prioritizing and understanding how you are going to spend the money and how long you want it to last. A financial plan helps you put it all together,” Ms. Dhillon says.
Depending on the assets being inherited, the financial plan can also help assess your asset allocation – and whether it’s in line with your short- and long-term goals. For instance, if you inherit a house or a cottage, you may no longer need to save to buy one of those types of properties in the future. Or, if you inherit an income property, you may wish to adjust your income to account for the revenues that will come from it.
“You need to ask: How does that asset fit into my financial plan?” Mr. Tanner says. That means taking into consideration cash flow, as well as tax and investment considerations.
3. Set up your own estate plan
Receiving an inheritance can often be a wake-up call for people to write their own will and set up a power of attorney – something that too often gets put off, Ms. Dhillon says.
Creating an estate plan can also help to minimize costs and taxes – to maximize your wealth.
“It’s your responsibility to make sure that wealth will be preserved and transitioned in case something happens to you,” Ms. Dhillon says.
Some people who receive an inheritance are also inspired to start or update their estate plan to make it a better experience for their own beneficiaries, Mr. Tanner says. Some clients ask, “What are some things that I can be doing to make sure this is a better experience or more efficient than my parents’ was?”
4. Join the conversation
Parents may not be prepared to give their kids a dollar figure around their net worth, but giving them an idea of what assets they have and how they could be distributed will help with the transition. According to the TD survey, only one in 10 respondents discussed how they would put their inheritance to use with the person who gave it.
In some cultures, talking about money is considered taboo. Or, sometimes children don’t want to discuss a time when their parents are no longer living. Still, experts like Ms. Dhillon stress that having a frank conversation about assets with loved ones is key to ensuring a successful wealth transfer.
“Where we see [wealth transfer] happening seamlessly is when there’s communication,” she says. While it can be awkward, she recommends using an advisor to help steer the conversation and ask the uncomfortable questions that parents and children may not want to bring up.
Mr. Tanner says he’s seeing more baby boomer clients starting to discuss estate planning with their kids. “The door is opening,” he says, adding that, “the more the next generation is involved in knowing what the estate looks like, the more they’re able to prepare.”
5. Don’t wait for wealth
Some adult children expecting an inheritance may believe they can spend most of their savings now, or don’t have to invest as much, knowing that there will be a cash influx later on. Ms. Dhillon advises against this approach given that people are living longer and circumstances can change.
“We always encourage clients to not rely on [an inheritance]. Make sure that you have a plan for yourself,” she says. “You don’t want to have a surprise – where you relied on something and it isn’t what you expected.”
She encourages millennials to start putting money away for their own retirement as soon as possible.
Both Ms. Dhillon and Mr. Tanner recommend millennials speak with a trusted advisor to help them sort out their finances, financial goals and how an inheritance can fit in with their longer-term goals and objectives, such as transferring wealth to their own children some day.
“It’s all rooted in the financial plan: How do we prepare for it as best as we can?” Mr. Tanner says.
Advisors can provide the big-picture look at your wealth, Ms. Dhillon says, taking into consideration a range of factors, including tax implications and return on any investments.
She says a good advisor is someone who sets aside their own biases and develops a financial plan that suits their clients’ needs and goals.
“As advisors, you have to go beyond the money side of it and understand what’s important to a client, their personality and their own biases and help them discover that,” she says. “You have to dig deeper and get to know your client.”