Families are awesome, especially when they can work together toward common goals. In fact, the ability of generations to work together can be a true wealth-producing machine. It requires a very long-term view, excellent family dynamics, and a little bit of education and “starter wealth,” but if done properly, it can be far more powerful than any other personal finance concept. If generations are willing to “cover” each other, they can increase their ability to take risk, decrease their need for expensive insurance-based solutions and decrease interest paid. Let me give you a few examples.
11 Ways to Build Family Wealth Across the Generations
#1 Youth BackStopping Retirement Savings
In decades past, there was no such thing as retirement. People worked until they no longer could, and then their kids took care of them until they died. Or until they took them out on the ice to die. Or whatever. Now that it is apparently a sin to rely on your children, people put a lot more effort into supporting themselves in their retirement years. But because they have to be self-sufficient, they cannot afford to take risks that they otherwise could. Instead of investing in risky assets with a high expected return, like stocks or real estate, the elderly are forced to diversify into bonds, CDs, and immediate annuities to ensure they don't run out of money.
However, if their children could provide the “insurance” against them running out of money, the elderly could not only have a higher withdrawal rate, but could also afford to take more market risk with their portfolio. How do the kids provide that insurance? Simply by being willing to let the elderly live with them or help with their living expenses from their current earnings. Another way to help would be by allowing the elderly to delay taking Social Security until age 70 by helping with living expenses until that time.
#2 Paying For College/Homes
Now, let's look at a way the older generation can help the younger generation. One of life's most expensive decades is the 20s. You have very little earning ability but lots of needs including an automobile, a college education, perhaps a wedding, and most importantly, a first home. Due to a lack of cash and earning ability, young people end up borrowing a great deal of money for these things, and not always at the best possible terms.
The more of this stuff that the older generation can pay for, the better off the family as a whole will be. In fact, it's even possible that the debt for one generation could be the income for another. There are IRS rules about how much interest must be charged, but when combined with gifting allowances, it's relatively easy to provide excellent terms on family loans.
Imagine being debt-free at 30. No student loans. No car loans. No credit card loans. No mortgage. You come into your peak earnings years and can immediately start saving for retirement and your own children's college. Instead of the family paying interest, the family is earning interest.
#3 Taking Advantage of the Step-up In Basis
One of the greatest gifts from the IRS is the step-up in basis that your heirs get on your assets upon your death. A great deal of estate planning can be done around this simple rule. Many times, if two (or three) generations work together, a family can avoid realizing a capital gain and allow that step-up to occur.
For example, grandpa needs some money and the only way to get it is to sell the family farm. That sale will generate a $2 million capital gain. It would be far better for the kids to provide grandpa the money he needs out of their own earnings or savings and wait for him to keel over to sell the farm. More money for each family member. The same thing can be done with stock portfolios, the family home, or the lake cabin.
#4 Gifting Rules
The gifting rule is a fantastic way to avoid paying estate taxes. In fact, it seems silly for anybody beyond the ridiculously wealthy to ever pay federal estate taxes when it is so easy to avoid them.
Imagine an elderly couple with an estate tax problem (a growing portfolio > $10 Million). They want to pass as much of that portfolio on to their heirs as possible. Well, how much can they pass each year? They can pass $15K each to each of their heirs. So let's assume they have 4 married children, each of whom has 4 married children each of whom has 4 unmarried children. That's a total of 104 heirs. $15K*2*104= $3.12 Million per year that can be legally moved from the portfolio to the heirs — estate and income tax free.
#5 What About the Generation Skipping Tax?
If you keep the annual gifts to $15K or less, the estate tax exemption ($11.4M per person in 2019) also applies to generation-skipping taxes. Just use annual gifts to reduce the size of the estate. In general, if there is no estate tax due, there should be no generation-skipping tax due. However, keep in mind the portability of the estate tax exemption between spouses does not extend to the generation-skipping tax. If you are a couple is in the $11-23M range, meet with an estate planning attorney in your state for some special planning.
#6 Stretch Roth IRAs
One of the greatest gifts you can be left is a Roth IRA. It's even better if that gift is left to someone quite young because the required minimum distributions are based on the age of the heir. It's possible for a Roth IRA to allow tax-free compounding for over 150 years if done properly, at least until/unless the SECURE Act in Congress in Fall 2019 is passed which will limit the stretching of Roth IRAs to just 10 years. In order to maximize family wealth, it's best to leave these valuable assets to the youngest person possible. While a stretch traditional IRA isn't quite as nice (since taxes are due on the withdrawals) it can still allow tax-protected growth for many additional decades if left to the right heir.
[Update 10/2019: Congress is discussing a bill that would limit stretch IRAs to just ten years of stretching before the balance would have to be withdrawn. It seems somewhat likely to pass.]
#7 Paying for Education
Just like it's best for the high earner to claim his college student as a dependent on his taxes, so is it best for the tax deductions to be concentrated in those who are earning the most. Education credits are far more valuable that way. Thus, the rich generation should pay the tuition bill. If they're not able to truly cover it, the younger generation can gift them the difference.
Likewise, parents may not be able to max out 529 contributions upon the birth of a child, but the grandparents might be able to — extending the period of time that assets grow in a tax-protected way. The result — fewer taxes for everyone.
#8 Estate Planning
There are many other great ways to pass money from the older to younger generations, including irrevocable trusts, spendthrift trusts, etc. It would be an estate planner's dream to have multiple generations of people who all get along with each other walk into her office and ask how best they can maximize their assets by working together.
#9 Asset Protection
Assets can also be protected from creditors by moving them from those with the highest risk to those with lower risks. Many docs already do something similar by titling the cars, boat, and house in their spouse's name. Why don't more people do this? Because they don't trust each other. Overcome that hurdle and all kinds of things are possible.
#10 Reduced Insurance Costs
The faster the next generation becomes wealthy, the sooner they can stop paying for unneeded disability and life insurance. Longevity insurance and long-term care insurance premiums can also be saved, further building family wealth.
#11 Teaching Financial Principles
The most important thing that multiple generations can do in order to maximize family wealth is to pass along the knowledge and values that allowed that wealth to accumulate in the first place. Most of us enter our 20s armed only with the financial knowledge taught to us by our parents' examples. Dedicated time spent teaching financial principles, both by example and more formal methods, can pay incredible dividends.
Teach your children to work, earn, save, invest, spend, and give wisely and you will have done much to increase and protect the family nest egg. If each generation views themselves as stewards of the family wealth, charged with preserving and growing it for the next generation, only good can come of it.
What do you think? What has your family done to maximize wealth through the generations? Comment below!
Hey Jim,
Check out this site. I read an article about it in Kiplinger’s a while back. Its an interesting idea, basically asking your family member to front your mortgage, replacing a portion of their bond allocation with it, and the interest money stays in the family rather than going to a bank. What do you think? Definitely relevant to the topic of this post.
https://www.nationalfamilymortgage.com/
Thanks for the website. I had always heard about minimum interest that must be charged on loans and it’s great to have the actual number now.
I love the ideas in this post but I would point out that “The Millionaire Next Door” writer showed in both his major books that children of well off parents who are provided education, supplemental income, or housing are generally less successful than those that aren’t.
I am all for starting a kids Roth early and helping them contribute. I would have loved to get 50K to help with a house, but outside of that… I would rather my parents enjoy there hard earned money that pass it along to me.
Beau,
The Millionaire Next Door (a book which I read, enjoy, recommend, and have bought for others) gets a lot of criticism for its methodological flaws, so be a little careful with that. The example you give, for example, can be easily explained by mean reversion. Lets say I’m a intelligent, hardworking spine surgeon making $850,000 a year. I have three equally intelligent, hardworking adult children, whose talents and interest took them into the fields of social work, film and tv production, and the military. And lets say I paid for all their educations. And their first cars.
All three children can be expected to accumulate wealth at a far slower pace than me, because they aren’t spine surgeons. The book will say that observation is caused by the financial help I gave them. I mean, MAYBE there was an influence because they were spared the sting of educational and automotive based financial pain and so weren’t motivated to go into high salary fields. But, come on, in reality, I am the outlier, not them. My kids are more representative of what normal humans earn. And very few people make doctor level salaries. Very, very few.
Its very easy to fall into the trap of labels, assumptions, and stereotypes when it comes to cookie-cutter financial advice. I’ve had to work very hard to break out of some of the financial “wisdom” and “common knowledge” handed down to me. But as has been said so often, “personal financial planner,” when done well, is really more focused on the PERSONAL part, then the PLANNING part, and less so the FINANCIAL part.
Classic correlation is not causation.
Thats very interesting. A few thoughts
1) You would have to be very comfortable with you child’s job/employability and they would have to be well insured. (A physician would be a good one)
2) The loaner would have to be comfortable with potentially a 25 or 30 year time frame for full return of investment. Thats a long payoff.
3) The loaner would have to want to do this to help family as they definitely could get better returns elsewhere.
I just read the millionaire next door and now paranoid about giving my kids anything. I would have loved to have had money covering my medical school tuition, or at least be paying that interest to my parents.
Justin,
Please see my comment to Beau above.
I think that this is a great article and a great idea. Very wealthy families tend to think globally about family wealth as well as individual wealth, and it pays off.
But I think it is something that needs to be approahced with caution by the average physician. We are well-off, but most of us don’t produce enough income and investment earnings to be able to have an automatic multi-generational effect.
I think there are a few separate questions that need to be asked and answered:
1. Do I have enough stashed away for retirement that I can afford to start cross-generational wealth building strategies, most of which will entail some element of risk? If not, then one has to really, really be confident in your children/grandchildren and their income-producing abilities and their financial acumen (not to mention passing the basic “good person” test). Or keep saving until you truly are done with saving for retirement and can afford to risk what you have over and above that.
2. Do one or more of my children/grandchildren “get it” when it comes to wealth-building? If you wouldn’t choose them as a business partner if they weren’t related to you, you shouldn’t choose them as a business partner just because they are. Taking wealth and transferring it to other generations as part of a family wealth-building strategy is a business partnership, plain and simple.
3. Will this particular child or grandchild be helped or hurt by being given wealth? The answer will vary, and you are a very lucky person if you can say that everyone (or a critical mass) of your progeny are the kinds of people who won’t be hurt by wealth transfers, of whatever size.
I was cut from the same cloth as my dad when it came to financial acumen and drive to create a setting of financial security and wealth for my family. So he did a lot of things that essentially amounted to wealth transfers, knowing that I would make the most of them, and I did.
I personally have had the level of confidence in my kids that I could promise them a paid-up undergraduate education and a new car, so they could enter young adulthood debt-free until it came time to buy a house. And they have not let me down — they lived more frugally in college than I did. I’m not yet financially ready to begin other kinds of wealth transfers to them, but even if I were, I would be cautious, for “Millionaire Next Door” reasons. I feel confident that there is no level of wealth transfer to me that would have blunted my own drive to work, succeed, invest, and build wealth. And my head was in the game already as a teenager. I’m not yet sure that is true for my kids. I feel quite certain that it will be by they time they are 30, but I’m waiting to see. It also depends on whom they marry…
Thats is just a great response/read. Excellent thoughs
The concept of compound interest is most powerful when implemented in a multigenerational fashion. If we on this blog think of ourselves as “the first generation” of wealth producers, we have more than the responsibility to invest wisely. We also have to spend time and energy educating our children and grandchildren these concepts as well. When I hear the ultra rich person in the news say that they will give away all their wealth and leave nothing to their children, it shouts: I don’t trust them and I didn’t take the time to teach them how to manage money. We wouldn’t not teach our kids to drive because they seemed too irresponsible. Likewise we should avoid leaving them money because we don’t think they can handle it…..TEACH THEM.
This is topic is handled very well in the book THE CYCLE OF THE GIFT by James Hughes and Susan Massenzio. Check it out.
I love The Millionaire Next Door but I feel it is short sighted in the realm of giving to future generations because it focuses on people who are self made and did not have the experience of inheriting significant wealth. Therefore they may not have had the experience or support to teach their kids how to receive significant wealth.
[Why would you think it is okay to spam my blog? Contribute to the discussion before advertising your book.-ed]
I was actually trying to post my previous questions (at https://www.whitecoatinvestor.com/the-stretch-ira/#comment-461726) on this blog post. Are you aware of any print or internet resources that dive further into these topics of building generational wealth? Sorry for blowing up your blog.
No, but there are good books about helping your kids by leaving them money in various ways.
Cool. Thanks. I found this book on the recommendations part of your website: Family Wealth–Keeping It in the Family: How Family Members and Their Advisers Preserve Human, Intellectual, and Financial Assets for Generations. Reasonable place to start or any other recs? As far as looking for online material I assume it’s just a matter of searching estate planning?
If you liked Family Wealth-Keeping It in the Family, you might also like these:
1) A Wealth of Possibilities by Perry
2) Preparing Heirs by Williams and Preisser
3) The Cycle of the Gift by Hughes, Massenzio, and Whitaker
4) Family Trusts by Goldstone, Hughes, and Whitaker
5) Family Wealth by Hughes
6) Raised Healthy, Wealthy, and Wise by Edwards-Pitt
7) Silver Spook Kids by Gallo and Gallo
8) Trustworthy by Goldstone and Wiseman
Thanks so much for the recommendations!
Another possible idea that came in via email:
I was recently informed of a possible
strategy (discussed on Bogleheads) for taxable account investing. One
would put their trustworthy parent on the account that they are
funding. Once said parent dies, one then steps-up the basis on the
account to clear any capital gains making any taxable account
essentially tax free investing with major caveats. First is that your
parent could fleece you with essentially no recourse, since for many
MDs we are talking into the seven figures for our taxable account I’m
sure that is a concern. Second is that your partner and you need to be
comfortable with the situation, I rarely even think about divorce but
wife brought this up (i.e. if the man’s parent is on it they could
instruct the parent to drain the account if the man felt they wanted
to get a divorce). I briefly ran this past my CPA who mentioned that
he believed you would need to count each deposit as a gift, but given
the 8 figure lifetime amount of gifting, provided you fill out the
gifting form on your taxes each year, this sounds like a minimal extra
requirement. Do you have thoughts on the legality of this?
feasibility? are people doing this? Thanks in advance!
Obviously you’d have to take your own name off the account completely to get the step up in basis.
I think there are a number of legal and family situations to cover for this to be a viable strategy.
Besides the “lifetime trusting spouse” requirement for the son, beneficiary designation and will execution would need to be bulletproof if there are siblings as potential heirs of the old man. What about his surviving wife, she would potentially need to disclaim inheritance, and it might be a future wife you don’t even know when executing this arrangement. And then there’s the all too common possibility of dementia or other incapacitation as the father ages and you need his cooperation to gift back some of your funds. A lot of potential pitfalls with this arrangement, but it could work in the right situation with the right legal protections. A lawyer who’s been around the block would be useful for advice and a trust could be advantageous. I would say that a family meeting of the minds would be necessary, too, but that would likely be only a temporary achievement.