The Great Wealth Transfer: What large advisory firms need to know

The Great Wealth Transfer What Large Advisory Firms Need to Know

We are on the brink of the largest transfer of wealth in American history. In the next 25 years, as much as $84.4 trillion from 45 million U.S. households will be passed down from older Americans to their Millennial and Gen X inheritors. This exchange of wealth and change in who the wealthy demographic is will dramatically shift the landscape of wealth management across the U.S.

The stakes are high for financial advising firms. Most firms have naturally focused on an older client base since they hold a significantly larger portion of wealth and have a higher interest in investments. If your firm’s clients are primarily over 50, it is likely the vast majority of your clientele will be completely new in the next 25 years. What comes after this turnover? Who will your firm be serving two decades from now? It is important to begin asking these questions now.

Financial advising firms’ long-term health relies on their ability to successfully navigate this transition. The ones that thrive will be the ones that can advise their older clients through the process of crafting strategic estate plans while welcoming the younger generation into the world of financial advising.

Baby boomers are preparing to pass on their legacies

The baby boomers (the generation born between 1944 and 1964) collectively hold between $30 trillion to $40 trillion in assets and control roughly 70% of all disposable income. They are expected to pass much of this wealth on to their Gen X and millennial children.

‘Older Americans hold more of the country’s wealth than ever before’

The U.S. Census Bureau estimates there are currently 73 million baby boomers in the U.S., and they make up the majority of most financial advising firms’ clientele. Today, older Americans hold more of the country’s wealth than ever before. They found prosperity in the post-World War II economy and have seen their assets grow during decades of rising stock markets, real estate values, and favorable tax policies.

While this generation has made good use of investments and financial planning, many of them lack comprehensive end-of-life plans. According to the U.S. Trust Insights on Wealth and Worth Report, 39% of wealthy individuals lack a comprehensive estate plan. For the most part, they have also avoided having conversations with their heirs about family fortunes and estate plans, leaving their inheritors unprepared for the sudden change in finances that will happen when they inherit.

Inheritors have a different relationship to finances

Gen X (born 1965-1980) will inherit 57% of the assets during the great wealth transfer, and millennials (1981-1996) will inherit the rest. These generations’ financial circumstances and attitudes toward money are significantly different than that of their parents.

Less wealth

Millennials have significantly less money on average, controlling only 4.6% of the nation’s wealth in 2020. They are less likely to own homes and have lower levels of financial literacy. More critically for financial advisors, the younger generations have less interest in investing in the stock market, possibly as a result of tight finances and skittishness resulting from coming of age during the 2008 financial crisis.

‘Younger generations are not engaged in financial advising and investments in the same way’

Income generators, not capital builders

Younger generations are not engaged in financial advising and investments in the same way as the baby boomers have been. Seventy percent of millennials are more focused on generating income than building capital in the long-term, according to the U.S. Trust Insights on Wealth and Worth Report. Most millennials have never received professional financial advising services, though a Vanguard Survey reports almost half have developed an increased interest in doing so as a result of the pandemic.

Preference for digital tools

Younger clients also gravitate toward digital financial tools and advisement services. Sixty-one percent of millennials see robo-advisors as a convenient way to invest, and this generation has gotten used to using apps and online financial tools to manage their money. This could make traditional financial advising firms less attractive to this generation, so firms will need to embrace technologies to stay competitive.

All these factors can be barriers to forming relationships with younger clients, but once they come into their inherited wealth, it will be important for them to have competent advising services to turn to.

How financial advising firms can support long-term success through the great wealth transfer

In order to see continued success after the current generation of wealthy clients passes away, financial advising firms will need to be strategic and broaden their idea of what financial planning can be and who it is for.

Keep generational wealth through strategic estate planning

Even if your clients have considerable fortunes to pass on, not all of it may actually reach the younger generations. Estate planning is key to making sure as much of your clients’ generational wealth as possible is preserved instead of being lost to estate taxes. For the ultra-wealthy, whose estates will fall above the estate and gift tax exemption, estate taxes can eat up as much as 40% of an inheritance and then another 40% as it transfers down to the next generation.

‘Estate taxes can eat up as much as 40% of an inheritance’

There are many strategies that can reduce that loss, but most financial advisors prefer to focus on immediately lucrative investing over estate management and tax mitigation. This is a lost opportunity to benefit their clients and keep assets with their firms. This is why Steve Lockshin, founder of Vanilla and AdvicePeriod, recommends advisors focus more on advising their clients on estate planning.

As an example, a firm has done incredibly well on investments for a $100 million estate during a client’s lifetime, making an 8% return on investment, beating the market’s 7%. That extra 1% translates to $1 million per year in alpha before taxes. However, avoiding transfer tax for that same estate with effective planning results in approximately $35 million in savings upon inheritance. Failing to plan for estate taxes can undo all the investing success a firm has made in a family’s lifetime.

Estate planning is also an opportunity to bring your client’s heirs into the conversation before they inherit. Including heirs in the estate planning process can mean more work for advisors, so it can help to use software like Vanilla that supports quick, easy digital communication.

Retain family business through the younger generation

Financial advising firms should establish a solid relationship with their clients’ heirs before they inherit in order to retain the family’s business. Studies suggest that the vast majority of heirs will not retain their parent’s financial advisor when they inherit. That’s unsurprising considering an MFS Investment Management Survey found 75% of financial advisors hadn’t even met their clients’ heirs.

Most people select their financial advisor through familiarity more than research. Lockshin explains the mindset, “Unfortunately, dealing with your finances is a lot like you are finding your primary care physician… they go and they ask their friends and they find someone that they like.” By establishing themselves as a trusted source for financial advice and education, a firm can make itself more likely to be kept on.

‘Establish a solid relationship with heirs before they inherit in order to retain the family’s business’

Inherited wealth is also notoriously difficult to hold on to. This can be due to a lack of financial education and preparedness. Only 50% of people have talked about how to manage wealth with their children. Parents may be reluctant to share information about their fortunes with their children, fearing they may become spoiled or lack motivation in life knowing they are in for a windfall inheritance.

This approach means that when those children inherit, they are financially uneducated and completely unprepared to manage their sudden wealth. It is better to step in and help families talk about money, investments, and end-of-life plans while parents are still alive and able to help guide their children.

Parents can also choose to begin handing down inheritance during their lifetime. A Merrill study, “Leaving a legacy: A lasting gift to loved ones,” 65% of individuals over the age of 55 wanted to gift at least part of their estate before their death. Financial advisors can help children begin investing that money in order to build their financial management skills. If a firm uses a tiered fee system, they can allow adult children to pool assets with parents to qualify for discounted pricing while still receiving individualized financial planning.

Make financial advising services more accessible to younger clients

Even if the parents of a younger potential client aren’t with your firm, attracting a younger clientele will help your firm’s longevity. Just because they don’t have a lot of wealth now doesn’t mean this generation won’t become wealthy later through inheritance or career success. It’s in a firm’s best interest to make this longer-term investment and help grow a more financially literate, younger client base.

Reducing investment minimums can make investing more accessible to younger people. Digital tools can play a key role in making planning more affordable for younger clients and more practical for firms by reducing the labor required of financial advisors, so they can serve more people and lower client expenses. “We try to use technology as much as possible to keep expenses down for the clients and charge them a fee that is appropriate for the level of complexity and the level of value that we bring,” Lockshin explained while being interviewed about AdvicePeriod’s success.

Embracing technology will also appeal to these clients since younger generations are more comfortable with online services and expect to be able to complete tasks, such as signing paperwork and transferring funds, fully digitally. A firm that can modernize its tools will engage this generation more successfully.

Forward-thinking firms can turn the great wealth transfer into an opportunity

With quantities of money in the trillions changing hands in such a short time frame, financial advising firms want to put themselves in a position to manage as much of that wealth as possible and help it grow for a whole new generation of investors. The next couple of decades will see a dramatic shift in the financial advising landscape. Firms that remain focused on wealthy older clients and traditional investing could find themselves falling behind as their clientele reduces in number.

But for firms that are forward-thinking and open to finding new ways of advising for new generations and the virtual era, this time of change presents an opportunity for success and longevity. Firms can future-proof their business by providing estate planning services, engaging a younger generation, and embracing the new possibilities technology presents. Serving a new generation as they come into wealth in their own way will open up new avenues of success.

Future-proof your business through estate planning

This article is for educational purposes only and should not be considered legal advice. If you feel that the information in this article is pertinent to your situation, you may wish to consult a qualified attorney for advice tailored to your circumstances.

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