ELITE ADVISOR BEST PRACTICES
Sounds great, but make sure clients know what they’re really getting into
By Hyman G. Darling
- Sudden wealth is life-changing for most people, and it can cause significant financial and emotional damage to the “lucky” beneficiary if they’re not ready.
- Clients who come into sudden wealth should take the time to figure out their short-term and long-term priorities before spending. The right team of advisors can help.
- Make sure clients have a qualified accountant, estate planning attorney and life insurance professional on their side to assist their investment advisor or financial consultant.
Chances are, you have several clients who’ve had the good fortune to become wealthy, usually very suddenly. It is usually a result of their receiving an inheritance or possibly winning a lottery. In these situations, there are several issues that need to be attended to fairly quickly. See related video.
1. Defer. The first issue is for clients to pretend initially that the money was not received. Before making any decisions, the money should be held instead of received, in order to avoid significant adverse tax consequences. For instance, if a client’s loved one passes away and an inheritance is to be received by your client, don’t request a partial distribution immediately, which may or may not include a distribution from an annuity or retirement plan. Once the funds are claimed and received, it becomes harder to postpone taxes and utilize other creative wealth protection options.
By not taking the money right away, the beneficiary (your client) has an opportunity to take a “step back” and determine their current and future priorities. It also gives clients the time to obtain the professional advice that they need in order to invest their assets as effectively and efficiently as possible.
2. Hire an attorney. It is very important to obtain the right team of advisors, and there are four types of advisors that clients should look for. First, obtain good legal counsel from an attorney who has expertise in estate planning, preferably one who has experience working with large estates. In addition to completing standard documents such as a health proxy, power of attorney and will, and possibly a trust, the attorney will also review the potential receipt of the funds and work with the other professionals to protect your client’s assets from future taxes or creditors’ claims. Perhaps your client, or client’s child, is a single person and planning to marry. In this case, a prenuptial agreement should be considered in order to protect the assets in the event that the marriage dissolves in the future.
3. Hire a CPA. The accountant is also a key professional to enlist, since taxes are always a concern for both income tax purposes and estate tax purposes. While many states no longer have an estate tax, the federal government’s share of an estate is currently 40 percent of all assets above the $5.34 million threshold. If the assets are being received from a decedent’s estate, and if estate taxes are paid, the assets in the recipient’s name are also going to be taxable when that person passes away. The accountant, working with the attorney, can assist your newly rich client in postponing future estate taxes or possibly eliminate them by creating entities that will be out of the recipient’s estate but will still provide the recipient with income.
Income taxes are a concern since the highest marginal rate is close to 40 percent, and with state income taxes and the possible Medicare surtax, the total income tax rate could be close to 50 percent. The accountant can certainly assist with planning strategies in order to minimize the “tax bite.”
4. Hire an investment manager/financial consultant. This professional needs to be involved as soon as possible to help your client determine how his or her newly acquired funds should be invested and to determine the recipient’s risk tolerance. This will help your client determine whether growth, income, gains or tax issues are to be considered, and in what dimension relative to the investment of the assets. If there are children or grandchildren who will receive gifts, then possibly other accounts, such as Uniform Transfers to Minors Act (UTMA) accounts, so-called 529 plans or other types of investment vehicles, could be established in multiple names in order to minimize or defer taxes for future generations. Most investment managers are able to provide sample portfolios with projected income and growth before a person decides to establish an investment relationship with them, and different investment options should be considered as opposed to going with only one proposal from an advisor.
5. Hire an insurance professional. For the newly wealthy person, insurance is also a key consideration. There are various types of insurance that should be reviewed. When someone does not have a lot of assets, there is not a significant liability if a person is sued. However, with newfound wealth, clients can become a target for lawsuits. All liability coverage for cars, homes, boats, etc., should be reviewed to increase the limits of liability. Liability coverage is not usually a significant expense, but still should be a priority. An umbrella policy that provides excess coverage in the event of insufficient liability coverage on other policies should also be considered. This is also a good time to review life insurance and potential long-term care insurance issues. For the newly wealthy, it’s important to determine what their needs will be if they pass away suddenly or become disabled—they don’t want to have a large portion of their inherited wealth spent on estate taxes or long-term care expenses without a plan to replenish those assets.
Other financial concerns should be considered by the client, such as their personal goals and any issues regarding education for children and grandchildren.
6. Review all major outlays carefully. Before paying off the mortgage, buying a second home, leasing a car, etc., all of your client’s major decisions should be reviewed by the team of advisors. Both tax and non-tax issues need to be reviewed in order to preserve as much wealth as possible. The team of advisors should also review a client’s desire to make “green investments,” to retire early, to volunteer for various charities, or to go back to school and change careers. While these goals are not necessarily financial decisions, they certainly have an effect on the larger picture since the need for additional income may be necessary.
The first thing a client should do when they know they are going to be receiving a significant sum of money—either in a lump sum or over time—is to STOP. They should assemble the right team of advisors and then determine what the game plan will be. Of course, taking a portion of the funds immediately to reward oneself is acceptable, but there are better and more efficient ways of utilizing money than merely spending after-tax dollars on newly found luxuries.