“I want to leave to my children enough money so that they would feel they could do anything, but not so much that they could do nothing.”
– Warren Buffett , 1986
“I must study politics and war, that our sons may have liberty to study . . . commerce and agriculture, in order to give their children a right to study . . . poetry . . .”
– John Quincy Adams, 1780
How much is too much? As parents and grandparents, this is one of the seminal questions we must all answer. Sadly, like many values-related questions that surface around money, there is not a clear answer. Like Justice Potter’s famed remark “I know it when I see it,” we all possess some sense of a consternation when it comes to giving money to future generations. Tabloid coverage of the Paris Hilton’s, Rich Kids of Instagrams, or other trust fund “brats” rests heavily on our minds as something to avoid.
We see two typical responses to the question of how much. One is either a passive response (aka I cannot tell my children no or I have not given it much thought). The other is an excessively controlling one (i.e. trust documents/structures that define the 900 possible categories for when a trust distribution is or is not appropriate). Neither approach though provides a satisfactory answer to this question of how much.
The passive approach can lead to entitlement or frustration on the lack of direction. The controlling approach can lead to the opposite of what was intended. In one survey of 3,250 affluent families conducted by two trust and estate advisors (Preisser and Williams), they observed that over 70% of estates become unglued after estate transitions. Meaning, that trust structures are unwound through probate litigation, rendering all the structures outlined moot.
As well, 90–95% of advisors are changed after an estate transition. So even for structures that stay in place, the advisors who knew the benefactors best and their values / philosophies are not going to be around to oversee implementation of the trust structure.
So of the 70% referenced above, why did they fail? 95% of the time — the actual plan was correct from a legal/tax perspective. Only 2–3% of failures were due to issues with the advice rendered. As Preisser and Williams noted, the assets were being prepared for heirs, and not the other way around.
Preparing the Heirs for the Assets
What we focus on for the rest of our discussion is how we can more thoroughly address preparing the heirs for the assets, alongside preparing the assets for the heirs.
Step 1 — Develop a Wealth Plan
“Mr. Wonka: “Don’t forget what happened to the man who suddenly got everything he wanted.”
Charlie Bucket: “What happened?”
Mr. Wonka: “He lived happily ever after.”
– Roald Dahl, Charlie and the Chocolate Factory
With no offense to Mr. Dahl, this is rarely the outcome. Seventy-five percent of business owners who sell their business say they are unhappy with the decision 12 months after sale. As well, eighty percent of individuals with a trust fund say that it has been a negative influence in their lives.
For most, wealth serves 3 primary functions. First it serves a defensive function, as it provides protection against the various unforeseen negative circumstances that arise in life. Secondly, it provides an easy score board for measuring one’s success. Finally, money enables consumption and a certain standard of living.
Generally, as folks earn/receive/invest/spend our financial resources, it is with one of those three contexts in mind. When we contemplate giving to others, it is likely due to a shift in financial posture. Perhaps self-obvious, but it is important to recognize. If we can begin to give to others, it implies that we have more than enough to satisfy our three functions from above — defense, consumption, success. This shift underlies the statistics mentioned earlier regarding the unhappiness of newly liquid business owners or trust fund beneficiaries.
As we reach a position of excess, the practical dollars and cents matter less, and the softer questions regarding values, legacy, and intention move to the forefront. Consistent with this level of wealth, a ‘wealth plan’ becomes a key document to think through and draft. This wealth plan would be a systematic examination of the question of what is all this money for?
Key elements to a ‘wealth plan’ would include:
- What are the most important values to you?
- What do you want your legacy to be?
- What do you own that you care about staying in the family and why?
Once this plan has been constructed, it is important to make sure that your estate plan, which actually defines how the money moves after death, is in accordance with the wealth plan. Ensuring alignment of these two plans requires the support of qualified and competent estate counsel.
Step 2 — The Giving Plan
Once the wealth plan is in place, you can begin to pivot and think about giving. In thinking about how much to give to your children and grandchildren, author David York recommends “focusing on the flint and kindling” and not the fire.
As we learned in scouting many years ago, starting a fire requires three key elements, a flint, a steel and tinder/kindling. When making a fire without matches, the steel strikes the flint to create a spark. The spark is captured by the tinder/kindling and slowly fanned into a roaring fire.
In passing on wealth to future generations, the issue underlying the proverb of “shirtsleeves to shirtsleeves in three generations” is that future generations lose the ability to create wealth. That is, as the mentality shifts from creation of the family fortune, to tending to it, and ultimately to spending it. In continuing our fire starting analogy from above, it is a different skill set to tend to a fire than create one entirely.
Yet the reality of families and family fortunes is that the assets of the family have to grow at a high rate to benefit future generations. Between the on-going impact of inflation, the multiplicative powers of pro-creation, and the negative impact of taxes, capital has to be compounded at a rate of easily 10%+ or more for the each successive generation to receive a benefit similar in size to the generations that have come before.
For closely held businesses, the forces of creative destruction are another risk. The primary assets that brought a family to wealth are simply not going to be able to sustain this growth rate into perpetuity in a competitive market economy. As such, the family must find new ways to grow and produce wealth -i.e. fire starting, not fire tending.
Do not misinterpret our point, the ‘fire-tending’ of existing assets must be done well with excellent corporate governance and sophisticated investment management. That is a necessary, but not sufficient effort for furthering the prosperity of a family. York’s advice then is to focus on creating the spark and providing the necessary resources to catch the fire.
As we think about giving to our kids, we should inquire of each gift if it is going to create the spark? Education and other chances to develop nascent gifts / talents are great sparks. If it is not a spark, is it providing the tinder to catch the spark? A modest amount of resources may enable the launch of a new entrepreneurial venture, or start a career that may have not been accessible without some financial assistance.
Author Lee Hauser uses the following categories to think of the various circumstances that a parent or grandparent could potentially assist with.
Needs by life stage:
- Birth to age 18
- College Years
- Early Career
- Marriage/Buying First House
- Provide for Handicapped Child (Grandchild)
- Healthcare Needs
- Incentive for Goal Achievement
- General Lifestyle Support
As you consider each category, you may or may not feel like giving at that stage is not appropriate, but hopefully, it helps you articulate where your line in the sand is.
Now for families of significant means, there are likely assets even beyond what categories they desire to fund. So the question surfaces of what to do in this situation. Hauser offer four other possible categories that could be helpful to fund:
– A Family Bank — for helping the family launch new ventures
– An Education Trust — for funding the education of future generations
– A Family Foundation — for supporting social causes important to the family
– A Legacy Trust — for supporting the family’s unity — regular gatherings, trips, etc.
Step 3 — The Communication Plan
“Without open communication about social and emotional implications of having wealth, inheritors may feel “ashamed of receiving handed-down wealth, guilt because they had so much, and inadequate when compared to the people in the family who made the fortune.”
– J.H. O’Neill, The Golden Ghetto: The Psychology of Affluence
The final step in giving is the communication plan. No doubt, this is an area of some sensitivity. In many cases, families do not want to reveal the full extent of the family’s wealth at the risk of hurting the children. We would agree that there is a certain amount of disclosure that is age appropriate based off the child’s developmental stage and emotional maturity.
Yet in our experience, there is a time when it is important to begin the dialogue of a more complete disclosure. We say begin, because all matters of great life importance take time to understand and digest, more so when complex financial fortunes are involved. Certainly great sensitivity and care must be given when children are inheriting at different levels than siblings or not at all. Nevertheless, better to begin this sensitive dialogue when the parent is present than risk the legacy of the relationship between parent and child, through the reading of the will following the parent’s passing.
We were struck recently in a conversation with a second generation family member of a family of significant means. This individual had some suspicion of the family’s wealth, but did not receive full disclosure, until age 24 upon completion of graduate school.
The level of the family’s wealth came crashing into her world for the first time, leading to a major reconsideration of her career choice and her responsibility to work within the family business. We cannot help but think that this individual would have been much better served through a series of progressive discussions detailing the family’s holdings and the likely impact of that on her own financial picture and professional aspirations.
Living well in the context of one’s financial means and values is no easy task. This is magnified even further when we decide to share those means with successive generations. Taking the time to analyze and thoughtfully draft a wealth plan, and then consider one’s gifting intentions provides the framework necessary to build a robust and comprehensive estate plan and an accompanying investment strategy to support it.