Managing Volatility: Inheritance Strategies for the Lower Upper Class

This week I’ve been reading Claire Tomalin’s Jane Austen: A Life. That’s risky for me to admit, as surveys show the female/male ratio of “Janeites” runs about 25:1. Mockery from readers may be unavoidable, and even deserved.

I think one of the most interesting aspects of Tomalin’s biography is how it shows the Austens and their neighbors as a case study of the Lower Upper Class.

Tomalin describes the Austens’ neighbors as:

“pseudo-gentry, families who aspired to live by the values of the gentry without owning land or inherited wealth of any significance… families who merely happened to be where they were at that particular time, some floating in on new money, others floating out on their failure to keep hold of old.”

Even though Tomalin wrote about families in 1790s Hampshire, I am hard pressed to think of a better description of the lives of the Lower Upper Class in America today.

For discussion purposes, today’s Lower Upper Class enters retirement with an asset base between $3 million and $10 million, and adult children of this class usually inherit more than $1 million each, but less than $5 million.

A qualitative view on those numbers is that in this class, there is usually a safety net of financial and/or human capital that’s sufficient for one generation, but not for more.

In plain terms, if children of Lower Upper Class parents are tripped up by bad luck, circumstances, events, and/or bad choices, the grandchildren will face a substantial risk of downward mobility.

On the upside, upward mobility is a distinct opportunity. As in Austen’s time, marriage to a high-earning spouse can create a pleasant shift into the Upper Class (Pemberley then, Palo Alto today?). Or, a successful run in an emerging “New Economy” business can create abundant wealth (the East India trade then, tech companies today?).

It’s hard for a family to stay in the Lower Upper Class over several generations – descendants tend to move up, or move down, but not simply tread water.

Successful inheritance strategies for this class need to manage volatility in descendants’ outcomes, and variability in their situations.

The Lower Upper Class has less wealth available to transfer than their Upper Class friends (and, possibly, extended family). Even so, they can choose among the same three inheritance strategies discussed last week: deferral, ad-hoc transfers, and income streams.

Deferral involves not giving adult children very much (if anything) until they survive their parents.

Ad hoc gifts are transfers for a particular purpose, such as paying off a child’s graduate school loans, or paying grandchildren’s day school tuition.

Income streams are arrangements providing ongoing cash flows to an adult child (regular “annual exclusion” gifts of cash or securities are a common approach).

In most situations, I think deferral is unlikely to be an effective Lower Upper Class inheritance strategy.

The reason is that maintaining a position in the Lower Upper Class requires substantial earned income. Being able to produce this income almost always requires substantial investment in human capital. In modern America, this often means very large expenses for independent school, college, and graduate school.

Because lifespans are increasing, if Lower Upper Class parents defer any wealth transfer until their children survive them, important human capital investment opportunities for children and grandchildren will be missed.

For Lower Upper Class families, ad hoc gifts tend to be a more attractive inheritance strategy.

If a family has a practical bent, it may make the most sense to focus gifts on targeted investments in funding economically relevant graduate school for children, and independent school and/or college for grandchildren.

Caution is indicated, because not all tuition payments produce similar returns on investment, and when available capital is limited, choices can’t always be avoided.

In families with many grandchildren, and adult children with expensive tastes for grandchildren’s schooling, the scope of educational investment can be so large that it becomes unwise for older generations to underwrite (given increasing lifespans, medical, and long term care costs).

Targeted investments to educate descendants can also raise difficult questions of fairness.

What if one sibling has fewer children than another? What if one sibling can cover his or her own children’s educational costs, and another can’t?

In these situations, I think a relatively easy estate planning option more families should pursue is equalizing differences in educational gifting among family branches when it is eventually time to divide a parent’s estate among adult children.

Income streams (such as through annual exclusion gifting) are another Lower Upper Class inheritance strategy. This may make particular sense for families that need to control growth of taxable estates, to avoid loss of wealth to estate taxes.

Making gifts to a spousal limited access trust can facilitate long-term equalization in wealth transfers among descendants. It can also allow parents to begin funding future investments in descendants’ human capital on a regular annual basis, even before grandchildren are born.

When a Lower Upper Class family uses its wealth effectively, it’s able to give its grandchildren an opportunity to avoid downward mobility, even when unexpected events and/or unwise choices disrupt the careers and lives of adult children.

To achieve this positive outcome, families in this class need to protect capital, but also be willing to use it at the right times and in the right situations.

Where does that leave us?

• For the Lower Upper Class, deferral is unlikely to be the best inheritance strategy.
• For less wealthy families, ad hoc targeted investments in college and graduate school for descendants are likely to be the best choice, and estate plans can incorporate inflation-adjusted equalization clauses to keep overall wealth distribution within the family substantially equal.
• For wealthier families who are managing estate tax exposure, income streams in the form of annual exclusion gifts (possibly to an irrevocable trust) are also likely to be helpful.

On balance, Jane Austen’s parents did a very successful job of launching their children into successful careers that consolidated and improved the family’s position, and increased opportunities available to their descendants.

Their greatest legacy to all of us, though, has to be Jane and her six wonderful novels. If you take some time to enjoy one of them, I think you’ll see a surprising degree of continuity between family situations and objectives in Regency England and America today.