How to Safeguard Your Heirs from Squandering Their Inheritance
- barmaley13
- Sep 4, 2024
- 7 min read
The challenge of preserving family wealth across generations is as old as wealth itself. There's a well-known saying in the United States, "from shirtsleeves to shirtsleeves in three generations," which suggests that family wealth rarely lasts beyond the grandchildren.
This sentiment isn’t unique to American culture. In Britain, the phrase "clogs to clogs in three generations" expresses a similar idea, and in Italy, there's a saying that goes, "from the stable to the stars and back again." These proverbs, originating from different parts of the world, all highlight the same fundamental truth: it’s incredibly difficult to maintain family wealth over time, and it often disappears within a few generations.
The numbers don’t lie
This cultural wisdom is backed by hard statistics. Studies have shown that 70% of family wealth is lost by the second generation, and by the third generation, 90% of that wealth is gone. This phenomenon is not just about money management; it’s about the entire process of inheritance, and how it is handled.
Traditionally, the emphasis has been on the wealth creators, those who worked hard to accumulate their fortune. However, equal attention must be given to the recipients—the heirs.
A successful inheritance is not just about passing down assets but also about ensuring that the next generation is equipped to handle and preserve the wealth. This preparation is crucial because without it, even the most well-crafted estate plan can fail to protect the family’s financial legacy.
Financial literacy and core values: a dual approach
Passing on wealth successfully requires more than just teaching financial literacy. It’s also about instilling the values that will help sustain both the family and its fortune. Financial education is essential, but it’s only part of the equation. To preserve wealth across generations, it’s just as important to pass down the principles and values that guided the original wealth creators. In other words, a successful inheritance is as much about parenting and mentoring as it is about money management. This approach is relevant not only to multimillionaires but also to families with more modest estates.
The hidden dangers of inherited wealth
It’s natural to view inherited wealth as a positive thing, but it can also be a source of significant challenges. First-generation wealth creators typically earn their fortune through hard work, perseverance, and learning from their mistakes. These experiences build character, discipline, and resilience—qualities that aren’t automatically passed down to the next generation. When the next generation inherits wealth without the same life experiences, they may not have the tools needed to manage and preserve it.
These challenges are why some wealthy individuals, like Warren Buffett and Sting, have chosen not to leave large inheritances to their children. Buffett, for example, has said that the ideal inheritance is "enough money so that they would feel they could do anything, but not so much that they could do nothing." Sting has expressed similar sentiments, stating that he doesn’t want to leave his children trust funds that become burdensome. However, this approach is relatively rare. Most wealthy parents do want to pass on their wealth, but they also want to ensure that their children remain grounded, healthy, and productive. The challenge is finding a strategy that accomplishes both.
A comprehensive plan to preserve family wealth
More families are recognizing the importance of preparing the next generation for the wealth they will inherit. To help ensure that family wealth is preserved and passed down successfully, experts recommend a five-step plan:
Talk openly about money
Discussing family finances can be uncomfortable, especially if parents worry that wealth might spoil their children. However, avoiding the topic only leaves heirs unprepared.
It’s important to be open about the family’s wealth, how it was created, and what the plans are for the future. This transparency ensures that children understand their responsibilities, and are not left wondering why they weren’t trusted with financial information.
It’s also important to explain how the wealth was created, especially if it was earned several generations ago. This helps heirs appreciate the hard work and sacrifices that went into building the family’s fortune.
Create a family mission statement
Your legacy should be about more than just money. Many families find it helpful to create a mission statement that reflects their core values—such as education, philanthropy, or self-sufficiency—and the purpose of their wealth.
After meeting with a family, wealth transition coaches often encourage family members to write down the values they want to emphasize in their lives. This process helps clarify what is important to the family and ensures that everyone is on the same page.
Teach financial responsibility from a young age
Financial education should start early. Even if you can afford to give your children everything they want, it’s important that they learn about budgeting, saving, and the value of money. These lessons help children understand that wealth is not infinite and must be managed carefully.
One simple way to teach financial responsibility is to give young children a piggy bank with three slots or three separate piggy banks—one for spending, one for saving, and one for giving. This teaches them the basics of budgeting and the importance of balancing their financial priorities.
As children grow older, you can introduce more complex financial concepts, such as managing an allowance to cover their expenses.It’s also important to let children experience the consequences of their financial decisions. For example, if a teenager doesn’t pay their cell phone bill on time, let the phone get shut off.
This teaches them the importance of budgeting and prioritizing expenses. By learning these lessons early, children are better prepared to manage larger sums of money responsibly when they inherit.
Provide Opportunities for real-world financial experience
It’s important to gradually introduce your children to managing wealth, rather than withholding access to the family fortune until they are older. One way to do this is by setting up a small investment account for your children when they are in their late teens.
Allow them to make investment decisions and experience the consequences of those decisions, whether positive or negative.Additionally, consider involving your children in managing family assets or charitable giving.
This experience will help them develop the skills needed to manage larger responsibilities in the future, such as running a family business or managing an investment portfolio.
Build a strong support network
Surround your heirs with a team of trusted advisors, including financial planners, estate attorneys, and tax specialists. This team can provide valuable guidance and help your children navigate the complexities of managing wealth. In addition to professional advisors, consider bringing in mentors for your children, especially for teens and young adults who may not always see their parents as the ultimate source of wisdom.
A strong support network can also protect your heirs from potential pitfalls, such as being taken advantage of by friends or making poor investment choices. For example, when young adults are approached by classmates or friends for contributions to investment schemes, a de facto advisory board can help them make informed decisions.
If the board says yes, the young adult is seen as a hero; if the board says no, it’s not their fault. This helps protect them from making impulsive or risky decisions with their inheritance.
Trusts: an essential tool for preserving wealth
Trusts are a crucial tool for preserving wealth and ensuring that it is passed on according to your wishes. Trusts can offer several benefits, including minimizing estate taxes, protecting assets from heirs’ mistakes, and maintaining privacy by avoiding probate. Trusts come in various forms, depending on your goals and the specific needs of your family.
For example, a revocable or living trust allows you to retain control of your assets while you are alive. This type of trust can help assets pass directly to your heirs, bypassing probate, but it won’t protect you from estate taxes. If minimizing estate taxes is your main goal, an irrevocable trust, which effectively removes assets from your estate, might be a better option.
Another option is a lifetime asset protection trust, which can be useful if you have concerns about your heirs' ability to manage and preserve the wealth they inherit. This type of trust can protect assets from creditors, bankruptcy, or even future ex-spouses because the assets belong to the trust, not the beneficiary.
When setting up a trust, consider including a personal message to your heirs. This message can convey your values and the stories behind the family wealth, making the trust more than just a legal document. Instead of simply imposing conditions or tying distributions to certain achievements, you can explain why you value certain things, such as education or entrepreneurship. This personal touch can help ensure that your heirs understand and respect the legacy they are inheriting.
By following these steps and preparing your heirs well in advance, you can give your family the best chance at preserving both your wealth and your values for generations to come. Investing in your family’s legacy is one of the most important things you can do, and it’s never too early to start.
While financial markets may fluctuate, and economic conditions may change, the principles and values you instill in your heirs will have a lasting impact. With careful planning and the right support, you can help ensure that your family’s wealth endures and continues to benefit future generations.
Have questions, schedule your no-obligation consultation here.
Sources*:
*These organizations are not affiliated with IFG. IFG does not endorse, support, or recommend any information that is not provided by its affiliates or representatives.
Disclaimer:
Information provided is for informational purposes only, and does not constitute an offer or solicitation to sell, a solicitation of an offer to buy, any security or any other product or service. Accordingly, this document does not constitute investment advice or counsel or solicitation for investment in any security. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation.
