Thoughts On Wealth And Children
And some attempts at useful takeaways
For many years I was part of a group of very wealthy people who met monthly to have confidential and candid conversations about having more money than was necessary, i.e., “excess wealth.”
Inevitably, the conversation found its way to the topic that caused the most angst: how to handle excess wealth with regard to children. What wealth to pass on to them and when. What disclosure to make and when.
Any parent wants their children to flourish, and it can be hard to distinguish between creating the circumstances for flourishing and passing on wealth.
Too much too soon without an effort at preparing children, and you likely stifle ambition, perhaps crush self-esteem, and create conditions for serious behavioral problems that can last a lifetime.
In childhood, too much too soon can take the form of giving your children a limitless credit card (parents really do this!) instead of some combination of an allowance and working. Or always having your children fly private.
As children grow into young adults, many wealthy parents will use money as a means of maintaining control over their children. Each and every luxury is a gift from parent to child conditional upon obedience.
Part of that control may involve a lack of access to information. Children aren’t blind. They know their parents have a lot of money, but they have no idea when or if any of it will ever become theirs.
In fact, some parents may pass on wealth to children when they reach early adulthood, but the money could be tied up in restrictive trusts that the children can’t use or don’t even know exist.
The message to the children is “we don’t trust you.”
To understand the motivations of wealthy parents to pass on wealth to their children, it is necessary to understand the inheritance tax code. The provisions, subject to change based on politics, are now so generous when it comes to passing on wealth, that parents can feel stupid for not taking advantage of the exceedingly porous status quo.
“A friend of the devil is a friend of mine”
The current tax code is a result of the Trump Administration’s 2017 tax law, engineered by Treasury secretary Steven Mnuchin shown above with currency bearing his signature, his wife looking on.
Here are some important gift and estate tax highlights of that law and others that preceded it.
A married couple can give away about $27 million over their lifetime to their children and grandchildren or at their death without paying federal taxes. That amount divided between two children would place both children in the top 1% of wealth. 1
An individual can give $18,000 every year, tax free, to each of their children and their grandchildren. A married couple, for example, could give a total of $72,000 annually to their adult child and their child’s spouse. 2
An individual can pay for health and tuition costs for their grandchildren. Private schools in Manhattan cost about $70,000. Some selective colleges cost even more.
As well, some rules and strategies are enormously beneficial.
Step-Up: When someone dies, their assets receive a “step-up,” meaning that neither the estate nor any of the beneficiaries pay capital gains tax. As an example, Jeff Bezos probably has close to a zero tax basis in his Amazon stock, worth now $150 billion or more. If he sold the stock while he was alive, he would have to pay taxes on that gain. But when he dies, for tax purposes, the value of his stock is “stepped-up” to $150 billion. So no tax will ever be paid on the gain.
GRAT: An individual can put an investment in something called a GRAT. The donor names a beneficiary. If the stock outperforms a low interest rate (set by Treasury), any excess passes tax free to the beneficiary. If the stock underperforms, the stock is simply returned to the donor. There’s no risk. 3
There are many other available loopholes that get increasingly complex.
In 2023, it’s estimated that only 4,000 estates in the country paid any Federal estate tax, and the total estate tax paid was about $24 billion. That sounds like a large number but it’s equivalent to only about 0.5% of Federal revenues, i.e., a rounding error. 4
That the current tax system is so porous is an important political issue affecting the persistence of economic inequality. The lifetime exemption of $23 million could be cut in half after 2025, depending on the outcome of the November elections.
In the meantime, a wealthy family has decisions to make.
Infinity and beyond
My wife Debbie and I came from different financial backgrounds. Her parents were self-made, and they taught Debbie thrift. My parents were inheritors of wealth. So Debbie was an invaluable check preventing me from spoiling our children. She insisted on an allowance and certainly no credit card.
(I wrote about the challenges of bringing up children in the Manhattan private school bubble in this post.)
On the Upper East Side, there was a luxury girls’ clothing boutique called Infinity. Debbie convinced me that if our then young daughter Lauren ever entered Infinity, where many of her friends shopped, it would mean instant and inevitable financial ruin for the family. Perhaps it had something to do with the store’s name.
The picture below is from a 2011 New York Times article about the store.
Our approach to money and children
Through trial and error, we’ve developed some approaches regarding wealth and our children.
Equality among children. This is universal, regardless of parental resources. I know wealthy people whose parents died owning only sentimental assets–– dishes and pieces of furniture passed down through generations. When an adult child did not get a proper share of their parent’s heirlooms, the emotional hurt was intense.
Transparency. We began discussing finances with our children beginning in their early twenties––they’re 30, 34, and 36 now. We have made an effort to make them feel as much independent ownership over what’s theirs as possible. No strings attached. We are actively available for advice and discussion. Lately we’ve been transparent about our estate plans. What it is and why.
The 3% rule. One challenge in talking about wealth is giving context and meaning to a given amount of wealth. The”3% rule” is one way to do it. You assume a long term, after tax investment return on wealth of say 5% and assume inflation of say 2% (these are the numbers I use; they’re not set in stone). That means you can spend 3% of your wealth without diminishing the spending power of the capital you have. So having an extra $50,000 means having an extra $1,500 of spending money. (The calculation is in the footnote.) 5
No mingling of our children’s finances. I’ve seen too many sibling relationships blow up over shared ownership of a house or a trust or any asset. This is true no matter what the value of the asset is.
“I’m Humbled”
The phrase “I’m humbled” has become egregiously overused as in “I’m humbled by receiving this honorable mention plaque bestowed on me by “The American Association of Candy Assortment Professionals.” 6
Truly, the phrase “I’m humbled” should be reserved for being a parent. No matter how thoughtful a parent may be or how hard we try, there is no chance of avoiding frequent mistakes.
It’s the most challenging job I’ll ever have.
Question for the comments: What should inheritance taxes be and why?
Four gifts multiplied by $18,000.
As an example, a parent could place a high risk/reward venture capital investment in a GRAT of which their children are the beneficiaries. If the investment goes to zero, then nothing happens and it’s as if the GRAT never existed. If the investment goes up by a factor of ten times, the children will capture almost all of the gain, free of inheritance tax, and the parent will pay the capital gains tax. Now imagine someone setting up multiple GRATs each holding a different investment. Some of those investments will succeed and wealth will be transferred tax free to the children. GRAT stands for Grantor Retained Annuity Trust.
If $50,000 earns 5% after tax, that’s $2,500. That means at the end of the year, you’d have $52,500. But if inflation is running at 2%, to keep the same spending power of the $50,000 at the start of the year, you need about $51,000 at the end of the year ($50,000 times 1.02). So if you spend $1,500, you’re even in real terms, i.e., after inflation. ($50,000 start plus $2,500 investment earnings less $1,500 of spending=$51,000.)
Actually, as a veteran candy assertor, now retired, with strong views and expertise on the subject––hard yes to Snickers and Good n’ Plenty and hard no to Milky Way––I would be honored if not humbled to receive a plaque attesting to my candy assorting abilities.
Enough to do something, but not enough to do nothing.
This follows up a nice exchange that we had on an earlier post. I think the timeline is the key factor: birth through 18 is what matters. If we raise kids in a comfortable but not luxurious lifestyle, including a economically mixed peer group and neighborhood along with a diverse school, than whatever amount of money they receive as adults will be filtered through well established norms and values. Having summer jobs that connect them to peers across economic lines is really important, along with taking out student loans so they are invested in their education. Vacations that highlight natural beauty rather than exclusivity. The goal is kids who feel comfortable moving between our socioeconomic layers, who have a strong work ethic, and who appreciate how lucky they are to live in this time and place. All of this takes discipline and delayed gratification by parents, which is not always easy, especially if the parents come from different economic backgrounds. "Normal" spending for one can be astronomically wasteful to another. But, to me, trying to stick to this approach is vastly preferable than the potential alternative of kids who do not share my values.