Generational Wealth: What Is It?
Financial assets passed down from one generation of a family to another are referred to as generational wealth. In addition to real estate and family enterprises, these assets may also include cash, stocks, bonds, and other types of investments. Due to its significant role in both the racial wealth gap and the rising wealth concentration in the U.S., generational wealth has recently taken center stage in talks concerning these issues.
Assets passed down from one generation of a family to the next are referred to as generational wealth.
Assets may occasionally be left to heirs as an inheritance after someone passes away. In other cases, they are handed on while the giver is still alive to the following generation.
Both the wealth gap between races and the wealth gap between the rich and the poor in the United States are influenced by generational wealth.
After death, generational wealth is transferred
The majority of generational wealth is passed down through inheritance upon death. Most American households receive rather modest inheritances. For instance, more than 55% of inheritances between 1995 and 2016 were under $50,000. In contrast, only 2% of inheritances were worth more than $1 million. Although few, the 2% of inheritances that were received accounted for more than 40% of the total wealth that was passed down; the 55% majority’s part amounted to less than 6%.
The federal government and, in some situations, the states impose an estate tax or inheritance tax on gifts that exceed a specific threshold. While inheritance taxes are paid by the individual heirs, estate taxes are paid by the estate. Most inheritances in the United States are below the $12.06 million ($12.92 million) ($2023) threshold that triggers federal estate taxes. There is no inheritance tax levied by the federal government.
Very few families are also impacted by state estate and inheritance taxes. To begin with, there are only 12 states that levy an estate tax, including the District of Columbia. Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington are the states in question. Every single one of them exempts the first $1 million in assets, and some of them set the exemption much higher.
There are estate or inheritance taxes in seventeen states. These taxes may differ based on the heir’s relationship to the decedent as well as income level. An inheritance from one spouse to another is not taxed. Rich families might use trusts and other legal strategies to reduce the impact of estate or inheritance taxes.
Transfers of Family Wealth Throughout Life
To benefit its heirs, a generation need not always pass away. Families have various options for transferring most of their wealth. These consist of:
Gifts
Families are exempt from paying federal gift taxes in 2022 if they transfer $16,000 in cash or property to each individual or $32,000 to each couple. So, for instance, a couple with four kids might give each child $128,000 tax free in 2022 and keep giving to them in subsequent years. When the exclusion increases to $17,000 in 2023, the same couple might donate $136,000 instead. Even in families with modest incomes, helping with a younger person’s first-time down payment is a typical intergenerational present.
Expenses for Education
Another typical method of transferring wealth is through the payment of education costs by one generation to the next. The tax code supports this by exempting tuition payments made directly to educational institutions from gift taxes; but, expenses such as housing and board, books, and other costs are not included in this exemption.
Medical Costs
Similar to tuition, gift taxes are not applied to qualified medical costs that are paid directly to the provider.
Wealth Gap and Generational Wealth
The top 10% of Americans currently control 76% of the nation’s wealth, while the lowest 50% own just 1%. Transferring money from one generation to the next is a big factor in that imbalance.
According to a Federal Reserve analysis from 2018, “the majority of intergenerational transfers are flowing to households that already have significant resources.” It was discovered that only around 20% of intergenerational transfers went to families in the poorest 50% of the population, while nearly 40% went to homes in the top 10% of the population in terms of income. Furthermore, just 8% of intergenerational transfers went to the bottom 50% of wealth distribution, while more than 50% went to the wealthiest 10%. According to the Federal Reserve, intergenerational transfers account for 72% of the wealth held by the top 10% of earners.
There may be other intergenerational wealth transfers at work here. For instance, education is closely associated to higher wealth and earning potential. Therefore, a family that can afford to pay for their children’s college education will have an advantage in building their own wealth.
The relationship between income inequality in a nation and the likelihood that its population would experience upward mobility is depicted by The Great Gatsby Curve. Inequality and a lack of upward mobility from one generation to the next are shown in graphs as having a strong positive association.
The Racial Wealth Gap and Generational Wealth
White families are more likely to have received an inheritance and to anticipate receiving one, according to a Federal Reserve analysis from 2020. For instance, compared to 6% of Black families, 4% of Hispanic families, and 15% of other families, 17% of White families anticipated receiving an inheritance. (Those who record more than one racial identity or who identify as Asian, American Indian, Alaska Native, Native Hawaiian, or Pacific Islander are included in the “other” group.)
A median inheritance of $195,500 was anticipated by White families, $150,000 by Hispanic families, and $100,000 by Black and other families, but White families also anticipated a bigger inheritance. The “race wealth gap,” which refers to the difference in overall wealth along racial lines, is caused in part by the inequality in inheritances. A typical White family in the United States possessed $184,000 in wealth in 2019, compared to $23,000 for a typical Black family and $38,000 for a typical Hispanic family, according to the Federal Reserve Bank of St. Louis. (Families with median wealth for their group are referred to as “typical” in this context.)
Black and Hispanic wealth increased between 2016 and 2019 at a quicker rate than White wealth, gaining 32% for non-Hispanic Black households, 60% for Hispanic families of any race, and 4% for non-Hispanic White families. This is a positive step toward closing the racial wealth gap. However, because they started out with significantly more money, White households continued to accumulate more wealth in terms of dollars.
The establishment of a wealth tax, higher estate and inheritance taxes, higher marginal income tax rates, and reparations for slave descendants are just a few of the proposals put out by those who favor doing more to reduce the racial wealth disparity in the United States.
How Can You Create Wealth for Future Generations?
Although generational wealth can take many different forms, it is frequently created through stock and bond investing, real estate ownership, business startup, or a combination of all of those. Additionally, effective estate planning helps ensure that generational wealth is not eroded by taxes that could be avoided.
What Qualifies as a Gift for Taxation Purposes?
Gifts are “Any transfers to an individual, either directly or indirectly, when full consideration (measured in money or money’s worth) is not obtained in return,” according to the Internal Revenue Service.
The Federal Estate Tax: How Much Is It?
The current federal estate tax rate is between 18% and 40% of the taxable amount, or the amount over the exemption.
The conclusion
Through inheritances and other mechanisms, American families can transfer wealth from one generation to the next, frequently without paying taxes on it. According to critics, the transfer of wealth over generations widens the gap between wealthy Americans and the rest of the population as well as between White Americans and those of racial minorities.
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