The well-known phrase “easy come, easy go” often is the theme behind the worries of many financially secure clients as they begin serious estate planning. Most clients will designate sons, daughters, nephews, nieces and perhaps a charity or two as beneficiaries. But here’s the haunting question: can a young beneficiary handle a lump-sum inheritance?
Some young adults are cool-headed and practical with money. But others simply lack the maturity to handle new-found wealth wisely and are at risk of blowing it on expensive cars, fancy clothes and luxury vacations. The money comes into their possession easily, then it exits just as easily.
In other cases, the beneficiary may have a permanent disability, so he or she will require a steady, lifelong income stream.
One solution for these scenarios is to set up a formal trust to dispense the money as prescribed by your client. But formal trusts can be complex and expensive.
Some Canadian insurance companies, including Montreal-based Standard Life Assurance Co. of Canada and Toronto-based Manulife Financial Corp., offer another solution for these scenarios: the gradual inheritance concept.
The gradual inheritance concept, also known as the “annuity settlement option” or the “gradual inheritance transfer,” provides a cost-effective and relatively simple way for your clients to leave their beneficiaries a steady income stream over a set period of time rather than a lump-sum payment. The gradual inheritance also is effective for those clients who are concerned that their beneficiaries may have spendthrift tendencies, are minors or will always be financially dependent due to having a disability.
“It’s a simple and flexible way to protect a client’s estate, and it gives the client a certain amount of control beyond the grave,” says Cheryl Norton, regional director of retail tax and estate planning with Standard Life in Vancouver. “And it can [help the client] avoid setting up a formal trust.”
For a life insurance policy with a gradual inheritance feature, the policy’s death benefit is paid to the named beneficiary under an investment contract via eligible investment vehicles, such as the insurance company’s annuities or segregated funds. Thus, Norton says, the gradual inheritance benefit is not part of the client’s will and, therefore, bypasses probate and estate fees.
“The gradual inheritance concept is really an informal trust vehicle,” Norton says, adding that this tool can be used only for liquid assets – and not for property such as real estate or jewelry.
In Standard Life’s case, the gradual inheritance money would come from the client’s investments in products such as a seg fund, an annuity with guarantees or the firm’s term-fund product, with beneficiaries named on the investment.
“For example,” Norton says, “if a client leaves money to a financially dependent beneficiary, [the client] could set up a life annuity so that after [the client’s] death, that beneficiary will be taken care of for life.
“But,” she adds, “if the goal is to spread the money out over a period of time for education or until the young adult beneficiary becomes more mature, then a ‘term-certain’ annuity may be the best option.”
Filling out the straightforward gradual inheritance application form is the only additional step required once the underlying financial product is in place.
Gradual inheritance is particularly helpful for clients who believe their beneficiaries may not be good at handling a sudden, large sum of money.
“This happens a lot,” Norton says, “especially when younger beneficiaries are involved and the client is not sure just how responsible the beneficiary will be in future. So, you leave [the beneficiary] an annuity payable over a set time period.”
Mary-Jane Wilson, a probate and estate lawyer and partner with Surrey, B.C.-based Wilson Rasmussen LLP, agrees that setting up a gradual payout can be a good idea for some clients.
“Often, the money that beneficiaries receive didn’t come from their life’s work,” says Wilson. “So, there’s an increased likelihood that they may spend it on good times.”
Wilson notes that any form of gradual payout can give the beneficiary a “taste” for the money without risking the entire amount.
“For young adult beneficiaries in particular,” Wilson says, “a gradual inheritance can be a good idea because, as they age, they’ll often become better money managers. In some ways, gradual inheritance serves as a bridge over the immature stage in a young adult’s life.”
However, Wilson warns, you must exercise caution when your estate work involves disabled beneficiaries. You must be aware that if the inheritance income is set too high, the disabled beneficiary may lose some government benefits.
“Above all,” adds Timothy Ross, a veteran financial planner based in Brockville, Ont., “when considering this [gradual inheritance] option, the unique aspects of each family’s dynamics should also be taken into account. In many cases, just looking at this concept helps your client start in establishing an estate plan.”
The gradual inheritance concept also works well for clients who want to leave money to a charity, Norton adds.
“Directors and executive members of charities often change, and they too can go through good and bad times,” she says. “So, the gradual inheritance has advantages here, as well over a lump-sum payment.”
Norton also sees the gradual inheritance concept gaining in popularity over time, although it is not well known within the financial advisory sector.
“This is why I give many presentations on the topic,” she says. “It’s obviously one of the more innovative and flexible products in a financial planner’s tool box.
“I think any time [an advisor] has an estate-planning conversation with a client,” Norton adds, “this concept should be raised – even if it doesn’t apply to the entire estate plan. It often works for part of the estate plan, however.”
This concept is not a substitute for a will, Norton says: “We always recommend that all clients have proper wills. The gradual inheritance concept often makes sense for part of an estate plan. And, any time you can offer advisors a tool featuring increased flexibility for clients, that’s a good thing.”
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