Trust Funds, Large Wealth, And Entitled Children

A couple days ago, I posted an article about how someone inheriting meaningful wealth should not feel guilty about receiving it because it reflected the will of the folks that created the wealth. Furthermore, money is itself a neutral thing–a tool if you will. Money can be used to accomplish great societal things and make personal dreams come true, but it can also be wielded tyrannically to exercise power over others and serve selfish desires at the expense of society. All it does is amplify the virtue and vices of those who possess it.

In that spirit, I wanted to discuss a topic that is very important to those who have accumulated much more in life than they could ever spend. And that is the question of what to do with the money when they die. Although there’s a limitless number of things that you can do with your wealth, the decisions generally relate to giving the kids the money, giving it to the kids plus family and select friends, charities, academic institutions, or some combination therein.

For today’s topic, I wanted to focus on a narrow subset within the “giving it to kids route”: Should you try to set up legally restrictive trusts so that the children can only touch the income and nothing else, or should the trust funds (and perhaps even tax-deferred and taxable investments) give the children the outlet to dissolve the trust, take the money, and completely screw it up?

To me, it is important that people have an opportunity to fail. The prospect of failure is partially what gives attaining success meaning in the first place. Otherwise, what value is there in creating a bubble-wrapped existence for a child that owes its comforts entirely to the prudence and labor of others?

Ideally, the children will have a chance to screw up early in life. Let’s say a kid receives a partial inheritance between the 18 and 22 age range. If the kid screws that up, then he is the beneficiary of a great learning experience. If a kid screws up a partial inheritance in his teens/early 20s, then he still has the rest of his life to learn from the mistake, and he would be able to learn from his mistake while the parents that created the mistake are still around so he could get still easily get things back together and move forward with his life.

But imagine if the trust is set up in a way that the kid could not possibly screw it up, and the child is basically wrapped up in financial and legal styrofoam. Then, what happens when the parent dies and the kid is on his own? Even if the parent manages to use tight legal structures to exercise control from beyond the grave, it then creates the dilemma of the child leading a meaningless existence. If a trust fund beneficiary has $75,000 in rents, dividend income, and bond interest coming his way every year, set up in a way that he cannot possibly screw it up, then there is a strong temptation to lead a life of loafing because the incentive to become economically productive would be muted.

The parent would run the risk of the kid turning into one of those people that responds to every person in charity with the adminition to “Get a job, you slob” and be completely devoid of sympathy for his fellow man. I’ve yet to meet someone that says “I want my kid to be an entitled little brat.” Well, when you shower unearned wealth upon a child in a way that he cannot possibly screw up, then the parent is laying fertile soil for the kid to develop an entitled mindset, because that is what happens when someone has material success (the $75,000 in passive annual income) without having to put forth the labor and prudent decisionmaking that was necessary to make it a reality. Bestowing large amounts of unearned wealth upon a child runs the risk of turning your advantage (abundance and wealth) into a disadvantage (by creating a child with a mediocre work ethic and lack of empathy for the struggles of others that do not have good fortune handed to them as an accident of birth).

It’s hard to qualify how this plays out, but sometimes, you see news headlines about how self-made businessmen generally tilt conservative and vote Republican, but the trust fund beneficiaries of these businessmen are even more conservative and hard-line Republican. It’s one thing to build a business and reach the conclusion, “I ought to be able to keep more than 65% of what I created with my own intelligence and labor, after accounting for state and federal taxes.” It’s quite another thing to be a 20-something year old cussing out Obama as you face an additional 3.8% surcharge tax on the $1.75 million left to you in a plain-vanilla taxable brokerage account.

If you are raising a kid that understands that money is a tool and he has his own internal motivations independent of money, then it probably does not matter how much money you give to a kid or how it is legally structured. If you honestly size your kid up and reach the objective conclusion that he has good values and a good work ethic, then you can feel comfortable giving him very large amounts of money because they will likely only amplify his good character traits (there is the risk that the money could be corrupting, but that would largely relate to age. A 30 year-old is not going to go change who he is in response to a large inheritance as much as a 20 year-old, all else equal).

However, if you reach the conclusion that the kid, quite frankly, cannot handle the money, then it might make sense to severely limit the amount of money that he can get. Bluntly speaking, if I was loaded and my kid was a bit of a brat, I would create a trust fund built on a foundation of $500,000-$750,000 that was set to pay out 1/2 to 2/3 of the median American household’s total income, somewhere around $25,000 to $30,000 annually or so. That way, if the kid turns around and gets his shit together after you die, you’re doing him a huge favor giving him a significant family blessing that will make sure he always has a roof over his head and food on his table. And if he has a typical job, then he will be able to afford vacations, perhaps a nicer home than he could otherwise afford, and of course, have the ability to invest that $25,000 to $30,000 in annual distributions. You can create a lot of wealth in a hurry deploying those distributions intelligently for a decade or so.

But I would not make the trust restricted. If the kid wants to take the $0.5 million after you die and blow it in Vegas, then having nothing would be a just outcome. Why should someone that cannot appreciate stewarding gifts from others have a right to a plush existence? If you cannot work, and if you cannot appreciate the efforts of those who came before you and did work, then having nothing is what should be deserved.

Originally posted 2013-12-08 01:10:52.

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