Advice for the Old from the Young

Here we flip ‘Young’ and ‘Old’ in the title of our first slide deck for this one described here with the intent of presenting ‘Personal Finance for the Old and Helpful Advice Younger People can offer the Old’. This looks at estate planning tools like wills and trusts and evaluates the relative merit of gifting assets while living versus bequeathing at death to charities and other beneficiaries. A brief overview of the entire lecture series is at this page. The entire slide deck is available at this download link.

Here we elaborate on a slide central to the message of the deck. This slide combines the essential content of readings in the chartered financial analyst program on lifetime financial advice by Ibbotson RG and that on estate planning in the global context by Horan SM. An explanation follows after the screenshot of the slide below.

The graphic follows a young adult entering the job market after attaining a skill set. At this junction, she has the potential for accruing wealth, and this she will realize over the course of her career. This is her ‘human’ capital – the yellow curve slanting downwards as she ages and represents her latent wealth. Her wealth through earning, her ‘real’ or financial capital increases as her human capital decreases. This is depicted as the blue line slanting upwards. The green line represents the sum of her latent and real capital and meets the blue line at retirement when she exhausts her human capital.

Some key read-outs by Mr. Ibbotson from this framework are that one must protect the value of one’s latent capital for beneficiaries, should there be an early death or disability, through insurance at an early age when there is very little accumulated financial capital. Further Mr. Ibbotson recommends investing financial capital in securities that are unrelated or uncorrelated to a person’s human capital (expertise). For instance, someone working in the real estate industry should ideally not invest in real estate mutual funds or mortgage-backed bond funds or he may find himself making less at work or even lose his job, while simultaneously losing a good portion of savings.

We leave out the scale for the y-axis as we will ascribe different scales for three different wealth accumulation scenarios. For the first, we will follow someone with inherited wealth who has human capital through acquired skills and a very supportive wealthy network. The blue line for this person is already at a few million as a young adult. He starts a business and at retirement is at a few 100 million. The core capital, the wealth level that would allow a net positive bequest to his survivors, despite an extravagant lifestyle in retirement, is likely at the little dark green bar well below the actual estate value at retirement. The dark green dotted line shows the wealth trajectory till bequest, when it may probably still be in the 100 millions. You would like to, if you could, be a beneficiary in his will or of any trust he establishes!

The next wealth scale we will consider will be that for a cardiologist who has just started practicing with perhaps about twenty thousand odd in the bank when she starts (or quite a bit in the negative with college loans). So the blue financial capital line would start close to zero or under, while the yellow latent line could be at about 8 million or so given all those years of schooling. She may eventually get to about 10 million at retirement. The little light green bar would be where she would need to be at to net positive at demise. The light green dotted line trajectory post-retirement could still leave her at about 4 or 5 million at bequest.

The third scenario will look at a professional in the lower middle earning potential range. As with the cardiologist, he starts close to zero but gets to a little less than a million at retirement. The core capital he would have needed to net positive at death is much higher at the red bar. This person may run the risk of running out of assets, especially if the death is preceded by a long disabling illness. There are ways out in this context such as the use of a reverse mortgage or a drawing down on any meager remaining assets to qualify for government support through Medicaid.

Drawing on results by Horan SM on ‘Estate planning in the global context’ we note in the rectangular boxes to the right of the graphic that gifting early can have a 3.1 fold and 1.6 fold relative value to a bequest for charitable and taxable beneficiaries respectively when the bequest is anticipated to be larger than the lifetime estate tax limit and a little low at 1.6 and 1.3 multiples for bequests below the lifetime estate tax limit.

Consult us for a further drill down, than that provided in our slide deck, on aspects of estate planning of further interest. Many aspects of the actual implementation of a will or a trust as part of your estate plan will require an attorney, but you can use us to help make choices between alternatives. You can reach us at advice@resourcetepee.com or at 551-233-6768 for personalized advice or a group course offering. Details on our fee schedule are in the FAQ page.