The following is a guest post by Robert Pagliarini, CFP®. Robert is a national expert on sudden wealth. This article originally appeared on Forbes.com.
If you are a parent who worries about what your wealth will do to your children, you are not alone. Many clients want to leave money to their kids, but they are concerned that their children are ill-equipped to handle sudden wealth. Some worry that by providing too much money that it will rob their children of the ambition and hard work that it took for them to amass the wealth. And it’s not just parents who worry. At least one beneficiary has reservations.
CNN news-show host Anderson Cooper is the son of Gloria Vanderbilt — a successful fashion and interior designer and daughter to the Vanderbilt railroad and shipping empire who is believed to be worth $200 million. Is Anderson chomping at the bit for an inheritance? No. Here is what Anderson said recently in an interview with Howard Stern:
“I don’t believe in inheriting money,” he said. “I think it’s an initiative sucker. I think it’s a curse,” Cooper went on to say. “Who has inherited a lot of money that has gone on to do things in their own life?” When Stern reminded him that his mother did this Anderson responded, “I think that’s an anomaly.”
What is your view of inherited money? Is it an “initiative sucker” or can it be used to create a better and more fulfilled life? In my sudden wealth management firm I’ve found that the answer is a resounding YES to both! Yes it can cause some to lose their drive and ambition, but with the proper work and structure, those who inherit can use the money as a tool to create meaningful lives of their own. But for many parents who are not convinced their children are ready to handle wealth, they are not idly sitting by hoping their children have a sudden flash of financial acumen. No, these parents are taking matters into their own hands.
If you are 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 gift tax consequence. If you are married, both you and your spouse can give $28,000 per person. Parents are gifting their children money without any restrictions or rules and then sitting back and watching what happens. How will your children handle a $5 million inheritance? 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 Suzie makes $75,000 from her job, the trust will distribute to her $75,000 each year. If her younger brother Johnny spends too much time playing Xbox and only makes $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 Suzie wants to join the Peace Corps? You can add language that will ensure distributions if your child is involved in a non-profit. Again, the sky is the limit when it comes to drafting who gets what and when. Newport Beach estate planning attorney Cheryl Barrett, says “I often build educational incentives in parents’ and grandparents’ trusts that are designed to reward the beneficiaries’ educational accomplishments.” For example, the trustee might be directed to disburse $10,000 upon attainment of a Bachelor’s degree and $20,000 upon attainment of a Master’s or Doctorate degree. While Barrett acknowledges that a degree is not a guarantee of a beneficiary’s personal success, she states, “The pursuit of it requires vision, goal setting, and engagement with other motivated individuals, all of which enhance a beneficiary’s likelihood of success.”
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 are older and, ideally, have a career and greater financial sophistication.
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 importantly 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. 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. There is another win-win alternative to outright gifting. Jeff Lewis, an estate planning attorney in Los Angeles likes this approach. Lewis says, “Many of my clients have started using their annual federal gift exclusion ($14,000 as of this writing) to directly pay down either an adult child’s mortgage principal or school loans. This will make a significant difference to the child’s future financial position, while not putting that amount of cash in their hands today.” Many parents realize that mortgages and school loans are substantially larger now than in their time, so helping to reduce that huge burden is a rewarding proposition for both generations. Lewis continues, “Be sure to check there are no pre-payment penalties or other negative loan consequences.”
As a parent, you want what is best for your kids. It’s natural and reasonable to worry how a large inheritance will affect their drive and choices for life. With some planning, money can be a tool that enriches their lives rather than an anchor that drags them down. Consider the strategies above and talk to your financial advisor and estate attorney for more ideas.