Estate planning is never easy. The mechanics of the process are easy enough but the big picture of how to disperse your assets require a lot of thought and soul searching. Those that have acquired a sizable estate need to think about the implications of leaving those assets to their children or grandchildren in a way that is prudent and won’t ultimately cause them harm.
As a financial planner, I am well acquainted with the problems that sudden wealth creates. Statistics on lottery winners show that 70% of them squander away their winnings in just a few years and are in worse financial shape than before they won. Other studies show that when new wealth is created in a family, there is a 90% probability that it will all be gone by the third generation. This is not the kind of legacy you want to leave for your family.
Being the recipient of a large amount of unexpected money may not automatically be a good thing. It ranks very high on the list of stressful situations a person or family can encounter and, depending on where the money comes from, there can be a great deal of guilt or regret attached to it. In the case of inherited wealth, people often stress over how to invest it “I don’t want to lose any of Dad’s money” or “These are the investments Mom chose and I don’t want to change them” even though they aren’t performing well. I have found that children that inherit a portfolio from a parent are reluctant to change the portfolio, even when it is not right for them.
How much should you leave the kids? The question of how much to leave the kids is a highly subjective matter. Of 30 multimillionaires recently surveyed by Fortune Magazine, six say their children will be better off with only minimal inheritances. Almost half plan to leave at least as much to charity as to their heirs. Should the money be left to children outright or in a trust? Some parents want to ensure that their heirs are leading productive lives before they get a share of the estate. Their wills establish trusts for each child — a sound estate-planning practice that can prevent the child from becoming a spendthrift and protect the assets in a divorce. Most estate advisers believe that 21, the age of majority, is too early for most children to inherit money. “Very large sums handed over to children who have done nothing to deserve them almost inevitably tend to corrupt them.” A prudent trust distribution scenario could start paying interest at age 35, and then allows access to principal in two installments at 40 and 45.
The best strategy is to educate your children about money and wealth and how to handle it is the ultimate safeguard against potential problems. Don’t think that you can just pass the money on and hope that in doing so you also pass on your values – teach them how to use wealth, the life to lead, the standards to have. Put child rearing before estate planning.
The education process can begin with annual gifting. In 2012, this annual gift exclusion is $13,000 per recipient. Any amount you give in excess to $13,000 per recipient is subject to gift tax or it can be subtracted from the lifetime amount that can be transferred tax-free at death. Some people think that if you give a certain amount of money to someone else, that person has to pay income tax on it. This is not true. The gift is not subject to income tax.
Observe how your son or daughter handles the money gifted. Do they save it, use it to fund their retirement accounts, pay down their mortgage or go on a shopping spree? Over time, do they come to expect the gift and count on it as part of their budget. I had a client whose child would run up their credit card bill in anticipation of the annual gift. They didn’t want to wait until the end of the year to spend the money. Encourage your children to enroll in a personal finance class to learn budgeting and debt management. You may want to adjust your estate plan if they are unwilling to invest the time to improve their money management skills.
Finally, bring the family finances into the daylight, so the children will know what they are getting and where it came from, and will have some idea how to hold on to it. This would also be the time to let them know why they are getting some of it (if part of it is going to charity) or why you are placing restrictions on the disbursement. These talks can evolve into full-scale sessions on the family finances and your values. It can also help eliminate problems between the siblings if they don’t believe they are being treated equally.
Ultimately, the best strategy to avoid creating problems from your inheritance is to teach your heirs to be responsible money managers while you’re alive.
- Estate planning requires careful thought. Leaving your children a lot of money is not necessarily a good idea.
- Consider having your estate distributed in pieces at certain ages.
- Educate your children and grandchildren about how to handle money and wealth through annual gifting.