How to protect beneficiaries from themselves.
Billionaire Warren Buffett was famously quoted as saying that when it came to leaving your children money, the sweet spot is “enough money so that they would feel they could do anything, but not so much that they could do nothing.”
Few of us need to worry about leaving our kids so much that they could comfortably choose to do nothing. But many middle-class parents do worry that certain of their children (or grandchildren) might squander an inheritance on drugs or gambling, make bad financial decisions, or be manipulated by a spouse. Some decide to cut out these problem children entirely, fearing that an inheritance would only make things worse.
But there are many options that fall between the two extremes of simply leaving money with no strings attached and leaving nothing. If you are concerned that any inheritance you leave your adult offspring could be quickly wasted, here are some steps you can take.
Disinheriting a Child
Parents do have the option of leaving nothing to an adult child. (Younger children may be entitled to claim part of a parent’s estate if it appears that the parent simply overlooked them—for example, by not making a new willafter the child’s birth. But the circumstances are limited and depend on state law.) Except in Louisiana, children have no right to a share of their parent’s estate if the parent deliberately left them nothing.
If you decide not to leave a child anything through your will, it’s best to make a statement to that effect in the will itself. You don’t have to explain your reasoning. Just name, in the will, each of your children and state that if you don’t provide for them in the will, it’s intentional.
Put Strings on the Money
If you don’t have confidence that your child will make good decisions about spending inherited money, you can put those decisions in the hands of someone else. One way to do this is by leaving the money in a trust, and appointing someone as trustee (the person who controls trust assets) you think will do a good job of doling out the money on behalf of, or to, the beneficiary.
But who will you pick as trustee? It’s not an easy job. The trustee will be responsible for investing trust assets, providing accountings, and making decisions about how to use the trust money for the benefit of your child. In the trust document, you can provide guidance about spending decisions. But it’s the trustee who will have to actually say yes or no to the child’s requests. It’s a lot to ask of a friend or relative, and especially difficult for any of the beneficiary’s siblings. You can hire a professional trustee (from the trust department of a bank, for example), but that has its own drawbacks: you’ll have to pay for the service, professionals are interested only in large trusts, and you’re delegating some very personal decisions to an institution.
The responsibility will likely last for years; how long is up to you. You can set an age at which the trust ends, and whatever money remains goes to the child outright. Or you can leave it up to the trustee; if he or she decides that your child no longer needs a money manager—for example, if the child has successfully battled addiction—the trustee could terminate the trust.
Leave a Trickle, Not a Lump Sum
One fairly simple way to control the flow of money to a child is to set up a trust and direct that the money be given out in installments—for example, one-third at age 25, one-third at age 30, and the rest at age 35. Or payments could be made yearly—it’s up to you. The person you choose to serve as trustee will have to manage the money, but won’t have to constantly make decisions about how to spend it. Instead, the trustee will simply make the distributions called for in the trust document.
An alternative to a setting up a trust, which entails legal fees, is to buy an annuity. An annuity is a contract with an insurance company that obligates the company to make payments to a beneficiary. Annuities are often used to provide retirement income, but you can direct payments to a child as well. You can arrange for regular payments of a set amount for a certain period of time, or variable payments that depend on investment of the underlying premium.
“Incentive trusts” are designed to reward behavior you want and discourage what you consider destructive. You can concentrate on the good behavior, and arrange for payments to be triggered by going to college or earning money. Or you can focus on what you want to avoid, and make payments contingent on, for example, completing an alcohol rehab program or staying free from drugs.
For the trustee, overseeing a trust like this is more complicated than exercising his or her judgment and following general principles you’ve set down. The trustee may need to investigate behavior and challenge the beneficiary’s assertions—not a pleasant task.
Lock It Up for the Long Term
For the very wealthy, a “dynasty” trust may be an option. If the pretentious name doesn’t put you off, you can set up a trust that’s essentially designed to last forever, or at least as long as the money holds out. Having the money in a trust can protect it from your descendants’ creditors, spouses, and bad judgment. It can also avoid some taxes.
Needless to say, these trusts are complex and must be prepared by a lawyer who has experience with trusts, investments, and estate tax rules.