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U.S. Inheritance Laws and Wealth Accumulation

Economists speak of the “crowding out” effect by government when it comes to borrowing money. Since the government often borrows in large quantities from private sources, there is less and less money for businesses and individuals to borrow who must then pay higher rates of interest on what is left. A similar effect takes place with respect to wealth. Because a small number of wealthy people hold enormous amounts of present wealth plus claims on most future wealth flows, there is very little left for people like you and me. In fact we have been so severely crowded out there is but a small amount of newly created wealth that can accrue to us. Only a tiny fraction of these wealth seekers can achieve their goals. I will explain the mechanism by which this occurs later in this essay. For now, suffice to say the odds of winning the lottery are better. And so, the idea that it is easy to become rich in America is the stuff of fiction. And because of the inheritance laws, the giant share of all future wealth will stay in or flow to the hands of the very rich. There is nothing you or I can do about it short of changing the laws that created the status quo. And you have a much better chance of turning water into wine than you have in changing those laws.

Wealth managers are perennial optimists. A wealth manager can show you the compounding effect of money over time, and the savings required to reach almost any goal. But so can a third grade dropout using a cheap calculator. The real reason why most Americans cannot and do not reach financial independence is not because they fail to plan for it, but because they neither factor in nor anticipate the costs of unemployment, or sickness, or divorce, or education, and that dreaded miscellaneous "other” category—factors that advisors never even try to put into their projections. One year of unemployment, for example, can wipe out a lifetime of savings. It also costs about $250,000 to raise a child to age 18, and approximately the same amount to send him to college for 4 years. Anyone who has been through a divorce understands how income and assets can quickly disappear, as well as can those who are greeted by the expenses of extended hospital stays, exotic drug expenses, etc. Since the bottom 50 percent of income earners receive an average of just $16,000 per year (Tax Foundation data), all in this huge group are up against a hopeless wall of obstructions to financial success solvable only by the Jessie James or Bonnie and Clyde strategies.

With that dismal introduction let me make a statement that will startle most economists, while it garners the wrath of virtually all wealthy people in the country wherever they may reside. Here it is: “96 percent of all wealth in America is inherited either directly or indirectly; only 4 percent of it comes from earned income.” This is a hurdle in your pathway to financial independence that you did not create, that almost nobody anticipates, but one that can and will stop you cold in your tracks short of divine intervention.

Before I set forth my proof for the 96 percent hurdle, I ask the reader to think about its implications. First, it means there are very few (if any) self-made millionaires and billionaires in America. Moreover, the odds of anyone becoming rich entirely by his or her own efforts are zero. In fact, you are only one among the 150 million or so wealth seekers who is scrambling for that 4 percent of new wealth that comes into existence independently from inheritances. And 4 percent of our annual wealth total increase today is about $280 billion. Divide that amount among the 150 million wealth seekers and the annual per capita rate is $1,870. If you want more you must outperform or outsmart your neighbor, perhaps many neighbors. Second, some wealthy folks would likely spend a lot of money in efforts to destroy me or my reputation if they knew about my statement. I am not concerned with that possibility because my tiny income is pretty much out of their reach, and there is virtually no chance they would understand this essay, even less that they might read it. Third, although common sense might suggest that I could not possibly prove my statement, I will nevertheless demonstrate that I pretty much know what I am rambling on about.

Here is what the term wealth means, and the source of my data.

Definition and Information Source. Wealth is synonymous with net worth, and net worth is equal to your assets minus your debts. Assets consist mainly of the market value of stocks, bonds, money market instruments, plus real estate. As you might expect the government tracks how much wealth we all have. As of December 2014, our total household net worth came to $81.5 trillion. You can find these data on page 117 of the U.S. Flow of Funds Report, published by the Federal Reserve Board. It is updated quarterly.

Wealth Calculations. If you examine the past 50 years of data from these reports and make the calculations, you will find the compound annual growth rate (CAGR) in our wealth accumulation is approximately 7.2 percent. This is a handy percentage that makes projections about future values very easy to calculate. By using the Rule of 72 we find the total doubles every 10 years without the need of a calculator or by using complex equations. Thus by the end of 2024 this total will be close to $163 trillion, by 2034 it will be $326 trillion, by 2044 it will be $652 trillion, and by 2054 it will be $1.3 quadrillion. Also, the “law of big numbers” assures us that these values are nearly certain to come to pass if the economy continues its long-term annual growth rate of 3.3 percent.

Now the calculations leading to the verification of my initial statement gets a little tricky. They rely partly on probability analysis and partly on logic.

The same historical data from the Flow of Funds report show that churches, schools, and charities hold roughly 2 percent of all wealth. Thus, the division is: 98 percent held by households; and 2 percent is held by churches, schools, and charities. These percentages have been relatively constant over time. And since the charitable component consists mainly of a voluntary flow of money, we may safely attribute it to gifts and bequeaths at the death of the benefactor.

And so, for estimation purposes I will assume that, on average, assets left at death are bequeathed 98 percent to individuals, and 2 percent to churches, schools, and charities,

Life Cycle of Inheritances. The average life expectancy today is 80 years for men and women combined. At death the average age of the decedent’s offspring, or beneficiaries, is 50 years. Thus, there is an average 30-year cycle in generational inheritances. The expected growth in inherited wealth is calculated thusly: An estate inherited at age 50 will double in value every 10 years by the Rule of 72. An estate of $10 million will therefore grow to $80 million in the 30 years from age 50 to age 80. Notice that this growth of $70 million can occur without any work, knowledge, or effort on the part of the beneficiary even though the beneficiary may perceive that he or she was the person responsible for the added value to the estate. My estimations, however, make no such assumption. Because the annual growth in stocks, bonds, and real estate is 7.2 percent, and that rate derives from the market, not from any one person’s efforts, it is an indirect result of the inheritance laws. In other words, without the inheritance, that passive gain could not have occurred.

Conclusions. Because 98 percent of all current wealth is inherited, and 98 percent of all new wealth is created from inherited wealth, it follows by probability analysis that .98 X .98 = .96, or 96 percent of all wealth is inherited, directly or indirectly. Further, because there is no work involved by inheritors of wealth, $78 trillion of all current wealth in the pool of $81.5 trillion in America is the consequence of the inheritance laws which required no effort by the beneficiaries.

Now you should have a better understanding about the $140 billion held by the Walton siblings (inherited from Sam Walton, founder of the Wal-Mart chain). And by the way, they pay no taxes on the gains produced by this wealth by exercising a variety of legal options which could be accurately called the means for “establishing and perpetuating a dynasty in America.”

It also follows that if you are not an inheritor of wealth, then you must have been responsible for creating part the wealth pool that somebody else owns, but did not produce, and on which they very likely pay no taxes. Further, there are enough legal hurdles and barriers in place that virtually guarantee you will never join them, not even in a small way.

Oh, incidentally, the federal taxes currently collected on inheritances amounts to about 0.15 percent of our annual federal tax revenues, by far the lowest of all tax rates. The wealthy and their cohorts in Congress call this an unbearable “death tax,” (alternatively how to “soak the rich”), and they have been fighting for years to eliminate it.

From all of this we are left with this final observation: Choose your parents wisely.