How do I pass money on to my children without spoiling them?
If you’re like most of my clients, then you’ve worked for years to pay off your debt, build a nice retirement nest egg, and create a solid financial cushion for your family. If you’re a younger family, then you likely have some equity built up in your house and a decent-size term life policy (or two) in place - collectively, well over a million in value.
Ideally, you’d like to leave everything to your children outright, but in the back of your mind you may be wondering “what are they going to do with all this money when they inherit it?” After all, what would you do if you were 25 or younger and just received a million dollars in cash?
I know what I would’ve done, and it doesn’t involve subscribing to the Wall Street Journal or making prudent investment decisions.
So the question is: how do you pass money on to your children without spoiling them?
Here are 3 ideas to make sure you don’t accidentally spoil your children with their inheritance:
1. Delayed wealth transfer.
Just because you'll be dead, doesn’t mean you can’t retain control over your property or its distributions for years to come. In fact, many clients will design their revocable trusts so they have staggered distribution ages for their children.
How does that work?
The most common scenario I see is to split up the distribution into three tiers. For example, “I give one-third to my child at age twenty-five, half of the remainder at age thirty, and all of the remainder at age 35.” This language is equivalent to three equal distributions if you do the math (assuming asset values don’t fluctuate wildly in between distributions).
Since this is your trust, you can make up whatever ages you think are appropriate based on your own experiences or based on how each of your children are wired personality and temperament-wise. Some kids seem to have a good head on their shoulders from a very young age. Others not so much, but they are trying (or at least that’s what they say).
If you are in the “but what about divorce?” camp - then you can go even further out. For example, I have clients that push the distribution age to 40, 50 (even some at age 60), with the idea that by that point the child will be established, have a good relational foundation with his/her spouse, and know exactly what to do with the money to make you proud. If they need it for their kids (your grandchildren’s college/education), then 40 might be the perfect age for your children to get the money outright.
But then you might be thinking - “what if they need money for something before then?” And that’s where the independent or disinterested trustee comes into play.
By having a third-party (i.e., not your child), serve as one of the trustees, you can authorize that person (for example a trusted sibling, cousin, niece, nephew, or advisor) to be able to make distributions at their discretion if they deem it appropriate for the beneficiary at that time. If no one comes to mind, you can still name a child as trustee and give them the option to name a co-trustee (subject to certain standards) to allow this optional discretionary function if appropriate.
2. Social Engineering
Social engineering your trust is the fun way to do it (in my humble opinion) if you have over a million to give to each child. Below that threshold would probably be overkill.
The social engineering idea is similar to the concept behind tax breaks employed by the IRS during tax season - for example, if you make a charitable donation, then you get a deduction - or if you invest in a qualified opportunity zone or hold onto an investment for a long period of time then you can get preferential tax treatment. In other words, you are incentivized to act in certain ways with your money in order to receive a benefit (i.e., more money).
The same can apply to your trust for your kids, but you make up the rules instead of the government (so long as it’s legal, of course).
For example, in the scenario mentioned above, the client will typically give a small amount outright to each child (e.g., 10-20% at age 25 of his/her respective share), and then condition the remainder on a delayed age (40 or 50) with exceptions or distribution carve-outs that allow the child opportunities to access money earlier under certain scenarios.
Here are some interesting ones that I’ve seen:
Milestone accomplishments like graduating from college, becoming a doctor, attorney (that’s a great idea), or other advanced degrees.
Passing a drug test or alcohol test consistently (more relevant if you suspect one of your children may have substance abuse issues).
Income matching - so if your child has a salary of $50,000 out of college, then the trustee is authorized to distribute up to another $50,000 from the trust each year (or a percentage you pick based on that compensation).
Matching charitable donations - if your child makes donations to a 501(c)(3) charity, then the trustee is authorized to make matching distributions up to that amount.
Starting a new business - sometimes clients will allow an early distribution to help fund their child’s startup idea to incentivize the entrepreneurial spirit (up to a certain amount each year). If you want to do this one with a twist, you could authorize the trustee to be able to make a loan up to a certain amount at a relatively low interest rate payable to the trust (kind of like an advance of the trust inheritance, but they are paying interest that they would receive in the future anyway so it’s a win-win.)
This is also a great way to get your child into real estate investing at a young age.
Financial planning - this could be meeting with your trusted financial advisor (or trustee) each year to come up with and stick to a financial plan that is prudent. If the advisor says they’ve met their goal (or simply show up to the meeting each quarter or year) then the child gets a minor distribution for building good financial habits..
I’ve also seen situations based more on personal values / beliefs rather than on financial prudence. For example, visiting your grave or attending a special family event each year to help keep the family together. Naturally, there are certain things you’d like to see your children do anyway (regardless of a potential payout), so maybe this would be counterproductive to the purpose of the article, but something to keep in mind if you want to keep a particular family tradition going for years after your passing.
3. Share Your Story and Instill Your Financial Habits
If you don’t want to rely solely on legalese to protect your children from becoming spoiled trust fund kids, then you could always make an extra effort to share the experiences that led to your wealth creation.
For example, do your children know:
how you got to where you are today?
why you pursued your particular career path?
the trade-offs and sacrifices that you made for the best interest of your family to build the wealth that you plan to give them?
Sharing your story can be a fun and enlightening experience for your children. Even though you may think they remembered how hard you worked or what you were doing those late nights at the office as they were growing up in their formative years, your children may actually be unaware of the struggles you went through.
If you are feeling particularly brave, you can tell them all the financial mistakes that you made along the way, so they are less likely to fall into the same traps. Maybe there was a point in your life when you were spending money trying to keep up with friends, neighbors, peers, or co-workers. I know I’m guilty of it.
Whatever your story may be, your kids will appreciate the insight and be more likely to appreciate what their inheritance really means. It’s not about the money, it’s about taking care of family and providing the best opportunities for them. If they can see and acknowledge that, then maybe they’ll think twice before spending their inheritance on a rolex.
If you’re interested in creating or updating your estate plan, then give me a call at 781 202 6368, email jlento@perennialtrust.com, or click here to schedule your free personal consultation.
I’m always happy to help,
Joseph M. Lento, J.D.
Your Local Estate Planning Attorney
www.PerennialEstatePlanning.com
477 Main Street
Stoneham, MA 02180
