What happens when wealth transfers skip a generation?

As with certain genetic traits, the passing of wealth sometimes skips a generation, with parents leaving children out of their will and choosing instead to provide an inheritance to their grandchildren.
Anecdotal evidence suggests this doesn’t happen frequently, but when it does, the impact on family dynamics can be damaging. In some cases, the deceased wealth owner’s wishes may be challenged in court.
That’s why it’s important to plan carefully for this particular route of wealth transfer.
“There are several implications to consider, including tax and legal implications as well as how this might affect relationships within the family,” says Steve Ivacko, partner in the family office practice of professional services firm MNP LLP in Vancouver. “From an estate planning perspective, this area is quite nuanced so getting the right advice and setting it up properly is key.”
For financial advisors, a critical starting point is understanding the reasons behind a client’s intentions.
“Everybody’s going to have a different motivating factor for wanting to skip a generation in their will,” says Gregory Moore, partner and portfolio manager at Richter LLP, a family office with locations in Toronto, Montreal and Chicago.
“There could be situations in which the children have had multiple marriages and the client wants to ensure the family wealth stays in the family, or maybe the second generation has already demonstrated significant financial success and the controlling generation doesn’t feel the need to leave money to their kids.”
In some cases, the decision to pass over the kids and leave money to the grandkids instead is rooted in strained family relationships, says Candace Cho, an estate lawyer and co-founder of Onyx Law Group in Vancouver.
“A common reason is that a parent is disappointed in their child and doesn’t feel they deserve an inheritance,” she says.
There are also situations in which a grandparent has taken a parental role because the children’s parents have abandoned them or done a poor job of raising them. “In essence, these grandchildren have become very much like their own children,” she says.
For some people, it makes sense to provide for a grandchild with a disability rather than leaving that money to their children, Mr. Ivacko says. But whatever their reason, they need to ensure that inheritance is structured properly based on what they’re trying to achieve and to reduce the risk of a lawsuit by other family members.
Typically, the most secure structure is an alter ego trust, Mr. Ivacko says.
“With an alter ego trust, the assets aren’t technically in an estate and not going through your will, so it’s a lot harder to challenge,” he says. “It’s a planning tool we often use in British Columbia, which has a broad wills variation capability and where it’s common, relatively speaking, to challenge an estate or a will.”
Those who decide to go with an alter ego trust should consider the costs of setting up and maintaining the structure, which will require filing an additional tax return each year, Ms. Cho says.
Wealth owners concerned about their inheritors’ ability to manage wealth – a reasonable worry if the grandkids are still young – might also want to look at a testamentary trust, which is typically set up within a will.
“Depending on how old the grandkids are, you could set up the testamentary trust so that they don’t receive the money until they reach a certain age,” Ms. Cho says. “But remember that the idea of trying to rule from the grave can get difficult as the beneficiaries get older.”
Taking the time to explain your wishes can go a long way toward ensuring the money you’re passing down is used as intended, Mr. Moore says.
An effective way to do this is through letters to the beneficiaries or a preamble to a trust. The latter would be part of the legal trust document but ideally written in a conversational style.
“In less legal language, you can set out what the intentions are for that capital,” Mr. Moore says. “What are you trying to achieve by way of giving your grandchildren access to wealth at some stage in their life? What’s the purpose of this legacy?”
The preamble or letter could also address the children and explain why they aren’t getting any money. Or, if a child is named as a trustee for the inheritance of a grandchild, these written communications could detail how and when the benefactor wants the wealth to be distributed.
“This can help them be a more thoughtful trustee who will ensure that ultimate distributions are made consistent with the values and principles that were articulated within the preamble, as opposed to just the technical intentions of the trust,” Mr. Moore says.
Jamie Golombek, managing director and head of tax and estate planning at CIBC Private Wealth in Toronto, says it’s a good idea to let the kids know in advance that they’re being passed over in their parent’s will. Those who have done well financially will often be fine with this decision and will likely be happy to learn their children will inherit the family wealth.
“Ultimately, it’s the parent’s money,” Mr. Golombek says. “With most of the clients we see, the money was generated through a business started by the parent – they’re the ones who made all the wealth and they ultimately decided what to do with it. I think that to the extent that one can have these conversations in advance, hopefully, you can try to avoid litigation or at least minimize conflict and resentment.”
Mr. Moore says it makes sense to include children’s spouses in these conversations given the impact on grandchildren.
When it comes to dividing the wealth among inheritors, it’s important to consider if the formula for allocation makes sense for the wealth owner’s intentions. For example, if they have two grandchildren from one child and four from another child, then giving each grandchild an equal share might be seen as unfair by the parent with only two children.
“What’s fair is not always equal and what’s equal is not always fair,” Mr. Golombek says. “One line of family might be getting more support than the others, but if they have more kids, then that might seem fair. There’s no right or wrong way to do this so you have to determine what you think is fair and then have that discussion openly with your children.”
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