It’s been said that if you have enough money to help your children through life, you also have enough money to ruin their lives. I see this scenario in my profession all the time. When young beneficiaries come in to large inheritances, they simply don’t know how to manage the new money.
A California estate planning attorney recently shared a story that is all too common. At age 27, the client was working as a waiter and studying to be a chef. Both his mother and grandmother died, leaving him more than a million dollars. The client quickly bought an expensive condo, a motorcycle and a car. At night, he frequented upscale restaurants and treated scores of friends to dinners and drinks.
Meanwhile, the client neglected to pay his bills or his mortgage. He lost his condo. Later, he crashed his motorcycle, which he was driving without insurance. The other driver in the accident sued. All told, within 17 months, the client had racked up debt, owed back taxes, lost his condo and was broke.
For people who aren’t versed in the art of holding onto (and better yet, growing) wealth, this type of windfall can produce the same result – a high-rolling lifestyle that ends in bankruptcy. This point is particularly true of young beneficiaries.
But, there is a solution. Most estate planning attorneys agree the best way to cure people of overspending is to put their inheritance in a trust.
Trusts are bank accounts that have set rules and restrictions on how funds will be managed and distributed. The trust’s creator decides what she wants the rules of the trust to be. So, in the case of inheritances, the person drafting their will can set specific parameters for how and when money should be paid to beneficiaries.
Often times, the trust pays out like an allowance over time, in either monthly or yearly payouts. In other cases, the trust provides for the beneficiary to receive a lump sum distribution once they reach a certain age, like 35 or 40, when they are mature enough to handle wealth.
Of course, the larger the amount of inheritance, the greater the risk of losing it all. Take another real-life example. Two siblings were minors when they received about $20 million in inheritance. As soon as they turned 18 and had access to the money, they began spending it wantonly. In just a couple of years, the two had spent about a quarter of their money.
Luckily, the siblings had an attorney who laid down the law – curtail the spending or lose everything. In the end, trustees took 95% of the siblings’ principal and purchased a lifetime annuity. Now, the beneficiaries live on just the money the annuity kicks off, which comes in at about $280,000 a year. Had the money not been structured that way, there’s no telling how much money they would have squandered.
From my experience, beneficiaries who begin receiving trust distributions at a young age often don’t know how to support themselves. Think about it. Receiving money-for-nothing gives the beneficiary a distorted sense of how easy it is to make a living. For a young person with little to no experience earning money, an inheritance that pays even $40,000 to $50,000 a year for the rest of their lives can give the impression that money grows on trees.
Beneficiaries of trusts often think their status as a “trust-fund baby” means they don’t have to work. Some begin spending as if they can afford to live high on the hog, and later, because they don’t bring in any income themselves, they run out of money. I’ve seen clients who, despite ample trust distributions, are in debt and hounding the trustee for more money to pay bills.
Coming into a large amount of money changes so much; it’s doesn’t just mean your bank account suddenly swells. Your tax situation changes. The way people approach you changes. Really, your entire life changes. If you’re not emotionally and financially ready for it, it can do a significant amount of damage.
So what measures can you take to ensure that the wealth you leave your children is more of a blessing than a burden? My advice is to make them wait, make them work, make them financially literate, make them save. And make them give. In the end, your children will be more self-reliant, and more appreciative of the gift you gave them.