Stories of “trust fund babies” who’ve squandered the wealth their parents carefully set aside for them to ensure their financial well being are all too common. If you’ve built up a large estate and are eager to share your wealth with your children, you may be concerned about their ability to handle it. Fortunately, there are steps you can take to help ensure they won’t blow through their inheritance at a young age.
Build incentives and flexibility into a trust
An incentive trust is a trust that rewards children for doing things that they might not otherwise do. Such a trust can be an effective estate planning tool, but there’s a fine line between encouraging positive behavior and controlling your children’s life choices. A trust that’s too restrictive may incite rebellion or invite lawsuits.
Incentives can be valuable, however, if the trust is flexible enough to allow a child to chart his or her own course. A so-called “principle trust,” for example, gives the trustee discretion to make distributions based on certain guiding principles or values without limiting beneficiaries to narrowly defined goals. But no matter how carefully designed, an incentive trust won’t teach your children critical money skills.
Put on your teacher’s cap
There’s no one right way to teach your children about money. The best way depends on your circumstances, their personalities and your comfort level.
If your kids are old enough, consider sending them to a money management class. For younger children, you might start by giving them an allowance in exchange for doing household chores. This helps teach them the value of work. And, after they spend the money all in one place a few times and don’t have anything left for something they really want, it teaches them the value of saving. Opening a savings account or a CD, or buying bonds, can help teach kids about investing and the power of compounding.
For families that are charitably inclined, a private foundation can be a great vehicle for teaching children about the joys of giving and the impact wealth can make beyond one’s family. For this strategy to be effective, children should have some input into the foundation’s activities. When the time comes, this can also be a great way to get your grandchildren involved at a very young age.
Consider distribution amounts and timing
Many parents take an all-or-nothing approach when it comes to the timing and amounts of distributions to their children, either transferring substantial amounts of wealth all at once or making gifts that are too small to provide meaningful lessons.
Consider making distributions large enough so that your kids have something significant to lose, but not so large that their entire inheritance is at risk. For example, if your child’s trust is worth $2 million, consider having the trust distribute $200,000 when your son or daughter reaches age 21. This amount is large enough to provide a meaningful test run of your child’s financial responsibility while safeguarding the bulk of the nest egg.
Or maybe you want to encourage financial success by making matching gifts equal to the amount of income your children earn each year. Be careful, though, not to accidentally dissuade your beneficiaries from pursuing other worthwhile though less financially rewarding endeavors.
Spell out your plans
Your estate plan can be a powerful teaching tool, but only if your children or other beneficiaries understand the lessons you’re attempting to impart. To avoid hurt feelings — or even litigation — it’s important to discuss your plans with your family. For example, if you set up an incentive trust for your children, communication is critical to ensure they understand your motivations and the values you’re trying to reinforce. Or if you’re limiting your children’s inheritance so they can make their own way, providing nothing more than a financial safety net so they won’t end up on the street should they fail, explain to them your reasons.
Whatever approach you choose, ensure that everyone in the family is on the same page. There are many ways to achieve this, including informal discussions, family letters explaining your intentions, structured family meetings and family mission statements.
Make your legacy last
If you plan on leaving a sizable amount of your estate to your children, consider incentive trusts, educate your children on money management and be smart with your distributions to them. Perhaps most important, communicate with your children about the reasons behind your decisions. These steps will increase the chances there will be money left to pass on to your grandchildren.
