By Dr. James M. Dahle, WCI Founder
Most people never save up enough money to retire comfortably. If people pay attention, run the numbers, save money, and invest well, they often punch out of the workforce right when they hit their number. That usually results in enough money to pay for their retirement and have enough left over for a small inheritance.
Then, there are a few people who through some combination of luck, frugality, and entrepreneurial skill end up with far more money than they will ever need. These people often find themselves supporting worthy charities. But many want to make life easier for their children and grandchildren. Sometimes they dream of helping their family get ahead for many generations to come.
Perpetuating Generational Wealth Is Hard
Unfortunately, it usually doesn't work, at least not for long. There are eight reasons why:
#1 You Had Too Many Kids
The first reason is entirely your fault. You had too many kids. Imagine for a minute that you die with $20 million. You leave $5 million to each of your four kids. They each had four kids. They're each left $1.25 million. Then, they each had four kids. The fourth generation is now left just over $300,000. Which is nice, but it is nothing like $20 million. It barely pays for a college education at some schools.
#2 Heirs Spend Too Much
Perhaps a bigger problem is that an heir left $5 million is unlikely to leave that $5 million behind. Heirs simply spend too much. Just to pass along an inheritance equal to what you received requires you to reinvest at least enough of the earnings to keep up with inflation. In reality, most heirs spend MORE than their inheritance earns, not less. People are people and most of them aren't savers.
#3 Estate Taxes
The federal government (and many state governments) tax money left behind above a certain exemption. While the current exemption is actually quite generous at $24.12 million for a married couple [as of 2022], amounts above that are taxed at very high rates. If you leave behind $100 million, about $30 million will go to the federal government. If you are a Washington state resident, you can kiss another $15 million or so goodbye. If by some miracle the estate is still large when the next generation dies, it'll get another massive haircut.
#4 No Hunger
Imagine how much wealth YOU would accumulate with even a relatively small head start. If I were given just $1 million dollars in my 20s, I could have doubled that six times by the time I died in my 80s! Or could I? It turns out that the more you have, especially if you didn't earn it, the less drive you have to earn more.
Stanley and Danko documented this effect in The Millionaire Next Door 25 years ago. Heirs who receive “economic outpatient care” don't actually get ahead; they get behind. They simply don't have the “hunger” that drove the first generation to build wealth. Beyond that hunger, they often don't have the intelligence or skills that allowed the first generation to build all that wealth. Even just trying to run the same business may not work out since the economy frequently changes, making older businesses obsolete.
Many well-to-do people put trusts in place and require pre-nuptial agreements that protect the family fortune from the ex-spouses of their children. But I'm sure a lot of them do not. Divorce is common and an easy way to cut an inheritance in half very quickly.
#6 Financial Catastrophes
The US is somewhat unique in that it has had a long run of prosperity without any really catastrophic financial events. Sure, we had the Great Depression, but it's been 90 years. We haven't had the hyperinflation that many other countries have experienced, nor have we had the devastation of Germany and Japan at the end of World War II. But if you look at the history of the world, it's pretty rare for any geographic area to go more than a century or two without one of these wealth-destroying events occurring.
#7 Failure to Inherit Money Management Skills
Great, you say. I won't leave my kids all that much money. I'll leave them a financial education instead. Then, they can make their own money. The government can't tax that, it can't be frittered away, and you can't lose it in a divorce. However, now we're playing the telephone game. Yes, you can probably do a pretty good job with your kids. And maybe between you and them, you can get to the third generation. But now you're relying on someone who was a teenager when you died to pass it on to the next generation. Something is likely getting lost in translation at each step, and within a few generations, POOF! It's all over.
#8 Family Fights
Jonathan Clements noted in 2020 that he is the great, great-grandson of an English tobacco baron. He received no inheritance. I don't think that's unusual at all. The Wall Street Journal says 90% of inheritances are gone by the third generation, but it says there's another big factor—family squabbles and lack of trust.
“Researchers at the Williams Group, a family-wealth consultancy based in San Clemente, California, surveyed more than 2,000 affluent clans over 20 years, searching for an explanation to the boom-and-bust syndrome among families. High taxes and poor investment advice were not the biggest factors; the study found that 60% of the time a trust and communication breakdown among family members played the biggest role. It's not hard to imagine squabbling siblings, mired in childhood resentments and rivalries, who can't agree on a schedule for the family beach house, much less how to manage Dad's business or which charities should benefit from the family's philanthropy. Helping to build trust among grown siblings or cousins, says Vic Preisser, managing director of the Williams Group, can be especially tough when they can only communicate about shallow things or aren't speaking to each other at all. ‘Wealth is a magnifier,' he says. ‘If you have problems, it will magnify them.'”
What Can You Do to Pass on Generational Wealth?
So, is it hopeless? I think it probably is. But that doesn't mean you can't make a big difference for a couple of generations, and maybe your family will be one of the rare few that pulls it off. Here are a few tips:
#1 Start the Financial Education Early and Keep It Going
If you're in this situation, start teaching your kids about money early on. Teach the dangers of debt, how to live below your means, how to budget and invest, plan an estate, and protect your assets. Teach them how to teach their kids. If you have advisors, enlist their assistance—before your death and after.
#2 Live Way Below Your Means
If you are making a ton of money and have a ton of money, there is no rule that says you have to live like it. You can live a middle-class (or more likely an upper middle-class) lifestyle. This will be much easier for your children to maintain from their own earnings +/- part of the earnings from their inheritance. But if they're flying to summer camp in a private jet, don't be surprised if they die penniless.
#3 Warren Buffett Philosophy
Warren Buffett famously said that he was going to leave his children enough money to do anything they want, but not enough to do nothing at all. There is a lot of wisdom there. We don't want our kids to struggle in the same way we might have (does every generation really have to donate plasma to eat in college?), but we also want them to work and earn their own fortune.
#4 Have Them Manage a Charitable Fund
It might be easier for them to manage money properly if the ability to spend it on themselves is taken away from them. Not only does your fortune last longer and do more good, but they might also learn from your example to build their own fortunes and perpetuate the family values. Serving together on a charitable board may also help preserve family relationships.
#5 Spendthrift Trusts
You don't have to give them their whole inheritance the day you die. You can pass the money in trust, so they are theoretically older and wiser by the time they get the lion's share of it. Perhaps there are more requirements to receive their inheritance:
- Get a degree
- Work full-time
- Save up their own first million
- Reach a certain age
- Be married with children
There are all kinds of options you can put in there, but make sure you think them through carefully.
#6 Skip a Generation
Although you need to be aware of how the Generation-Skipping Tax works, any time you can skip a generation, you extend your fortune that much longer. An easy example is to open 529s for your grandkids. That money won't count on the FAFSA, and your children can't spend it before the grandchildren get to it.
If you are in the fortunate position to have more than you need, carefully consider how you might use that fortune to benefit future generations.
What do you think? How will you preserve your family fortune? How long do you think it will last? Did you inherit significant money? How did it affect you? Comment below!