An inheritance can give your children just the financial boost they need. They could use it to pay off lingering debt, for a house down payment, to contribute to a kid's education or just to provide extra peace of mind. But if you're concerned about some of the undesirable effects an inheritance can have on your children, you aren't alone.
Many of my clients want to leave money to their kids, but they're concerned that their children are ill-equipped to handle sudden wealth. Some worry that providing too much money will rob their children of the very ambition and work ethic that it took to amass the wealth they want to pass down.
What's your view of inherited money? Is it an "initiative sucker," as CNN's Anderson Cooper (who's the son of Gloria Vanderbilt) recently called it, or can it be used to create a better and more fulfilled life?
In my sudden wealth management firm, I've found the answer is a resounding yes to both. Yes, it can cause some beneficiaries to lose their drive and ambition. But also, with the proper work and structure, those who inherit can use the money as a tool to create meaningful lives of their own.
However, many parents who aren't convinced their children are ready to handle wealth aren't idly sitting by hoping their children have a sudden flash of financial acumen. Instead, these parents are taking matters into their own hands.
If you're also concerned about gifting or leaving your children an inheritance, consider these popular strategies:
1. Give your kids a financial test. Each person can gift up to $14,000 (in 2014) per year to as many people as they wish without any federal gift-tax consequence. If you're married, both you and your spouse can give $28,000 per person. Some parents are gifting their children money without any restrictions or rules, and then sitting back and watching what happens. But how would your children handle a $5 million inheritance? Instead, why don't you see what they do with $20,000 first? Do they save it? Do they ask for help? Do they pay off debt? Do they blow it in Vegas?
2. Use incentive trusts. The fear of many parents (and apparently Anderson Cooper) is that too much money can squash ambition and drive. The image that keeps many affluent up at night is the idea that their kids will be robbed of zeal to make an impact -- this same zeal and inner drive that pushed them to make their own mark on the world.
The solution for many parents is to use incentives within a trust rather than leaving a large inheritance outright. The incentives can be as creative as you can imagine. For example, a common incentive -- euphemistically called an "investment banker clause" -- calls for trust distributions that match the child's income. If Susie makes $75,000 from her job, the trust will distribute $75,000 to her each year. If her younger brother Johnny spends too much time playing Xbox and makes only $22,000 a year, the trust will distribute just $22,000 to him.
The built-in incentive with this clause is, of course, to make money. But what if Susie wants to join the Peace Corps? You can add language that will ensure distributions if your child is involved in a nonprofit. Again, the sky is the limit when it comes to drafting who gets what and when.
3. Tie distributions to ages and events. Think back to when you were 20 years old. Would you have been emotionally and intellectually mature enough to handle a large inheritance? Many parents create their trust so that their kids get a small amount of money each year and larger amounts when they reach certain ages (e.g., 30, 35, 40). They will also allow for trust distributions to pay for college expenses, weddings or house down payments.
A popular strategy is to distribute income from the trust assets when the kids are young and then to distribute principal when they're older and, ideally, have a career and greater financial sophistication. Estate planning attorney Mark Ziebold sees many trusts set up to distribute at certain ages, but under the laws of most states, this destroys the possible protection that parents can provide for their kids in trust. He says:
"Instead of distributing assets at certain ages outright and free of trust, consider having your estate attorney draft provisions into your trust that keep the assets in trust for your child for life, but that if certain ages or triggering events occur, the child will be able to become their own trustee over their lifetime trust. Instead of outright distributions at 30, 35 and 40, consider allowing them to be trustee of one-third of their trust at 30, trustee over one-half of the remaining at 35 and trustee over the entire trust at 40. Alternatively, they can at a certain age be a co-trustee with an independent trustee and be involved in the entire process of the trust administration. These ideas allow the child to either be their own trustee or involved as a co-trustee, manage their assets inside of the trust and keep the protection of the trust structure in place for their lifetime."
4. Get your kids involved in a personal foundation. If you have children still living with you, creating a personal foundation can be a wonderful opportunity to support causes you believe in, get a nice tax deduction and more important to our point, teach kids about money. One of my clients sold his business and overnight was worth more than $25 million. He and his wife had three young kids, and they were worried that the dad's strong work ethic would be lost on the kids now that they could have anything they wanted.
So, we created a personal foundation, and because it was required to disburse 5% of the foundation's balance each year, we gave each family member the responsibility of researching a cause and donating 1%. This got each of the kids excited about their own cause and seeing how their money could have an impact. It was a great learning experience for the whole family.
5. Give without giving cash. Here's another win-win alternative to outright gifting. Clients can use their annual federal gift exclusion (that $14,000 or $28,000) to directly pay down either an adult child's mortgage principal or school loans. This can make a significant financial difference to the child's future while not putting cash in their hands today. Many parents realize that mortgages and school loans are substantially larger now than in their time, so helping reduce that huge burden is a rewarding proposition for both generations.
6. Teach them early. If you still have young children, now is a great time to begin their financial training. Los Angeles estate attorney Bruce Sires suggests that you "start early to avoid the worry."
He goes on to recommend:
"Give them an allowance, and discuss with them how they're going to spend it. Maybe give them some 'ideas' like saving part of it or giving part of it to a charity that's important to them. If you start early and they see the value of saving, when they get to middle school they can start investing. They will learn the value of money, and you will be a better guide by watching what they do, or don't do, and encourage and reinforce the positive. Don't fall into the trap of showing them what a great investor you are. It's all about their future."
As a parent, you want what's best for your kids. It's natural and reasonable to worry how a large inheritance will affect their drive and choices for life. However, with some planning, money can be a tool that enriches their lives rather than an anchor that drags them down. Consider these strategies and talk to your financial advisor and estate attorney for more ideas.