Don't Depend on Inheritance to Fund Retirement

DON’T DEPEND ON INHERITANCE TO FUND RETIREMENT

Baby boomers depending on an inheritance to help fund their retirement may be putting their retirement at risk, warn many financial planners and other retirement experts.

The headlines have been enticing for baby boomers. A 1993 study by two Cornell University economists estimated that $11 trillion ($14 trillion in 1999 dollars)[CLU article in Heirs file] would pass to baby boomers between 1995 and 2045. Two Boston College economists upped the ante to $41 trillion dollars spread over 55 years, and other estimates have ranged as high as $136 trillion! With money like that waiting around the corner, why bother to save for retirement?

The reality is, baby boomers need to concentrate hard on saving for their own retirement because large inheritances are not likely to materialize for most boomers, say many retirement experts. They cite a variety of reasons for their conclusions.

First, what inheritances do pass on will be highly unequal, and will be spread out over decades. The Cornell economists estimated that the average estate passed on would be worth $90,000—hardly enough money to pay for 20 years of retirement. But that’s just an average. Some heirs will receive considerably more, many will receive considerably less. Experts estimate that 37 percent of the nation’s wealth is controlled by 5 percent of the households.[CLU Journal, Heirs file] A study released in 2000 by the Federal Reserve Bank of Cleveland calculated from a 1998 federal Survey of Consumer Finances that 92 percent of those people receiving inheritances received virtually nothing, while a mere 1.6 percent received more than $100,000. Yet a study for AARP found that over half of the “leading edge” of baby boomers expects to receive an inheritance that will help fund their retirement. [Estate planning file]

Another factor likely to limit the amount of potential inheritances is that today’s older generations are living much longer than previous generations. You may be well into retirement before receiving a bequest. Furthermore, older generations are spending more of their accumulated wealth, not only for basic expenses but for a more active retirement that might include such activities as travel or entertainment. Longer lives also increase the likelihood for long-term care, whose expenses can quickly eat into an estate.

The study by the Federal Reserve Bank of Cleveland also contends that a significant portion of the wealth is annuitized—that is, it is being paid out in regular payments for retirement. Many of these payments will end when the annuitant dies. Social Security benefits account for part of this, but current retirees also are more likely than baby boomers to receive retirement income from employer-sponsored defined-benefit plans. Payments from these plans will stop when the annuitant dies. Baby boomers, on the other hand, rely more on defined-contribution plans, whose accounts can be passed on when the boomers die.

Furthermore, says the Federal Reserve study, though the dollar amounts passed on may be larger than in previous generations, the inheritances don’t represent a greater share of the boomers’ economic resources than the inheritances their parents received. That is, relative to their earnings, boomers are receiving only slightly more than their parents did.

Experts also argue that today’s retirees, especially wealthier ones, are less inclined than previous generations to leave substantial wealth to their heirs. Billionaires such as Warren Buffett have made it clear they will give most of their money to charity, often in the belief that their children should “earn” their wealth, not inherit it.

What will be your specific situation? Financial advisors recommend that children talk over potential inheritances with their parents. This can be a delicate subject: older people often don’t like to talk about their finances, and children may not want to appear greedy. Bringing in an outside financial advisor to provide an objective third-party perspective can be helpful.

Examine strategies that can minimize the financial loss on an estate. For example, some baby boomers are buying long-term care insurance for their parents so that expensive at-home or nursing home care doesn’t drain their estate. Furthermore, despite the possible repeal or reduction in estate taxes, tax planning will still play a role in estate planning.

But the real key, say financial planners, is to not rely on an inheritance to fund your retirement. It may not be there when you most need it.

April 2001— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by McGuire & Co., LLP, a local member in good standing of the FPA.