The key to recognizing underutilized wealth is to look at the entire family and all five elements of family wealth. In his 2007 book, Family: The Compact Among Generations, James E. Hughes lists the following five elements of a family’s wealth: human capital, intellectual capital, emotional capital, spiritual capital, and financial capital. Consider these elements as a guide to successfully redeploying underutilized wealth. Here are some reliable indicators of underutilized wealth.
Vacation Homes, Nonresidential Farms, and Forestland:
We often encounter clients with lake, beach, or mountain homes. These assets are financially and emotionally important to clients. Some clients are particularly interested in having these assets remain in the family, preserved for future generations. Generally, these homes are not income-producing; sometimes, they are cash drains. Nonresidential farmland and forestland may or may not be income-producing and, again, could be emotionally important assets. The important questions to ask here are:
- How much does it cost to maintain these properties?
- Is there an expectation that they will be available to future generations?
- If these properties are transferred, what will be needed to cover the cost of holding if they are not income producing?
Pensions, (Particularly U.S. Government or Large Multinational Corporations That Still Have Rich Pensions):
When we encounter a client who has a good pension, or a client who is simply thrifty and able to live off Social Security, we almost always find underutilized wealth.
- If a client is able to live comfortably off income from Social Security or a pension, what is he or she doing with IRA distributions?
- What is happening with the dividends from his or her stock portfolio?
- What is happening with the simple interest from his or her CDs?
Usually, investment income is being reinvested. While it is certainly important to keep a rainy-day fund to provide for long-term care and other issues, any assets beyond immediate needs and an appropriate cushion are almost certainly underutilized wealth that can be transferred.
Regular Gifting to a 529 or UTMA
Clients who gift regularly to a 529 or UTMA have already acknowledged underutilized wealth and taken steps to redeploy these underutilized assets. That is the good news. The question is whether the vehicle and ownership support other goals. If owned by the applicant, 529s are includable assets for Medicaid and must be exhausted before qualifying. Transferring ownership will trigger the 5-year look back. The questions to be asked regarding 529s are:
- Who should own them?
- If Medicaid is a possibility, how are they to be funded in the future?
We often recommend that the 529 be transferred to an excluded trust or to competent middle generation children.
UTMA are not Medicaid assets, but come with their own issues. Our greatest concern is whether the donee will be ready to receive this gift at 18. It is the old “Harley vs. Harvard” issue. Give some thought to the client’s overall situation and the best use of these assets. This client is 85% there; they know they have underutilized wealth and are willing to redeploy. The only question is whether the 529 or UTMA is the right vehicle or titled appropriately.
Regular Annual Exclusion Gifts
This is similar to the prior discussion of 529s and UTMA accounts. Clients who regularly maximize their annual exclusion gifts (currently $15,000.00 per person per year) have already made the journey. These clients have recognized underutilized wealth and have begun to redeploy. Once again, the question is about maximizing the benefit of these gifts. If the gifts are outright, the proceeds are subject to the recipient’s divorces, creditors, and taxes. It is also the case that these gifts lose their impact over time. If the result is just more spending by the donee generation, are we perpetuating the family’s wealth? Targeted gifts can be more effective.
- Gifting to a trust holding life insurance or an annuity based on a young life might create a lasting source of wealth.
- A targeted gift for the grandchildren’s education might allow a struggling young parent to maximize his or her own retirement contribution,
- Gifting income-producing assets to a trust for a younger generation might be both tax efficient and create a meaningful change in the recipient’s life.
These indicators should be seen simply as sources for further discussion and analysis, and should always be taken in the context of the family's total wealth picture: the family’s human, intellectual, emotional, spiritual, and financial capital. Legacy Counselors is here to help. If you are interested in learning more about underutilized wealth, please give us a call. We will be happy to assist.
Please visit our blog later this week for Part II and Part III in our series on underutilized wealth.
Hughes, James E. (2007) Family: The Compact Among Generations. NY, NY: Bloomberg Press.