Advisor Forum preview: Dealing with sudden wealth

(December 1, 2004) For most people, a million-dollar-plus inheritance would be a dream come true. But there are a number of pitfalls to an inheritance of that size. That’s where advisors can offer valuable assistance to heirs, says tax expert Tim Cestnick.

“The larger the inheritance is, the greater are the challenges your client will face in dealing with that money.”

The most obvious pitfall is spending too much too soon, because the client considers the inheritance a windfall. “If the client wants to go crazy and spend some money, then let them take 5% of the money and just blow it.”

But there’s also the potential for negative psychological responses, Cestnick warns, such as paranoia, boredom, immaturity and inadequacy.

“Immaturity and paranoia are the most common. Inheritors can be spared life’s challenges. It can inhibit your growth as an individual.”

As for paranoia, heirs with large amounts of money can become targets of other people’s material desires, says Cestnick, managing director of AIC’s tax and estate planning group.

“New friends are coming out of the woodwork and you have to question their motives. People tend to start mistrusting other people. Relationships become more difficult to establish. There’s not a lot that advisors can do about that expect help them deal with it. Clients who avoid flaunting their wealth will minimize those kinds of problems.”

Early retirement is another common response to a large inheritance, but Cestnick says it’s not always the right move, citing the example of a 35-year-old man who inherited a million dollars and immediately quit his job.

“I’ve never met a more miserable guy because he didn’t plan how he was going to spend the rest of his life. You don’t just go quitting your job, there’s planning to be done, such as what are you going to do with your time?”

There really are only four options for inheritances, says Cestnick: invest, spend, pay down debt or give it away. The correct strategy depends on the client’s circumstances.

“If the client has debt, but has a stable income and a weak retirement nest egg, the number one option would be to invest the money or invest some and pay down some debt. But a client with no debt, a stable income and a strong nest egg could spend more, while still investing some.

Of course, being a tax expert, Cestnick has a number of useful tips for maximizing inheritance by minimizing tax. “Make sure wills are set up so that their heirs will inherit more rather than less,” he suggests. “Trigger losses in the first year of the estate. Any losses realized by the estate in the first year can be carried back to the final tax return of the deceased individual to offset any capital gains or other income.”

Dealing with the principal residence properly is also an important consideration. “If the plan is to sell the residence of the deceased shortly after they die, make sure that no beneficiary lives in the place before it’s sold. That’s because if the beneficiary who is due to inherit the property lives there, it becomes a personal use property and you can’t claim a capital loss.”

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For more of Tim Cestnick’s tips on inheritance maximization, go to his presentation at next week’s Advisor Forum in Toronto (Dec. 8-9). For details, check the Advisor Forum website.

Filed by Doug Watt, Advisor.ca, doug.watt@advisor.rogers.com