Complexity does not arrive all at once. It accumulates in layers, each one added for a perfectly rational reason at the time, and together they create a…

Complexity does not arrive all at once. It accumulates in layers, each one added for a perfectly rational reason at the time, and together they create a balance sheet that can take years to untangle.

Start when a family begins to accumulate wealth. Early in the wealth-building years, when cash flow is limited, the first savings outside of a primary residence go into employer-sponsored retirement plans - 401(k)s, IRAs, profit-sharing plans. The incentive structure of qualified retirement plans is hard to combat for a family building their net worth from a small base – an income tax deduction on the way in, employer matching, and tax-deferred growth. The result is that retirement accounts often represent the single largest financial asset for families with a net worth of $5 to $10 million, and sometimes for even wealthier families.

Beyond retirement accounts, early-stage wealth is still primarily marketable securities managed by a financial advisor, growing equity in the primary residence, and a collection of personal property (cars, art, jewelry, collectibles). These assets are administratively simple. They have a market price. They can be sold with a phone call, some Internet research or a visit to a reputable store.

The complexity inflection often begins as wealth accumulates, and typically through any number of “great” opportunities: a financial advisor recommending alternative investments, or a friend offering a deal. Sometimes it starts when someone makes partner or receives stock options - life is no longer as simple as it used to be. Private equity funds, hedge funds, real estate partnerships - each one sounds like a good idea when it is pitched, and many of them are. But each one also adds a K-1, an additional set of advisors, a capital call obligation, a distribution waterfall, and a set of governing documents that nobody will read until something goes wrong.

By the time a family crosses $20 million or $50 million in net worth, the balance sheet often reflects decades of individual decisions - each defensible in isolation, many made for tax reasons, some made on a golf course, a few made in a moment of enthusiasm - layered on top of each other with no unifying logic. There is no unifying logic, but there is a unifying source. Every one of those decisions was made by the same person (and their hand-selected advisors), which is why two families with identical net worth so often end up with balance sheets that look nothing alike. Real estate in three states. A position in a private equity fund holding various operating companies. A carried interest from an old business deal. An oil and gas royalty. A donor advised fund. A life insurance policy inside an irrevocable trust.

All of these holdings will have to be dealt with - by someone - when the owner dies or is no longer capable.

Part of the Wealth Machine Series (adapted from my paper for Notre Dame Tax and Estate Planning Institute presenting October 30).