Stories of “trust fund babies” who’ve squandered the wealth their parents (carefully set aside for them to ensure their financial well-being are all too common. If you’ve built up a large estate and are eager to share your wealth with your children, you may be concerned about their ability to handle it. To help ensure your children don’t blow through their inheritance at a young age, consider the benefits of an incentive trust and teaching your children about money management.
Build incentives and flexibility into a trust
An incentive trust can be an effective estate planning tool, but there’s a fine line between encouraging positive behavior and controlling your children’s life choices. A trust that’s too restrictive may incite rebellion or invite lawsuits.
Incentives can be valuable, however, if the trust is flexible enough to allow a child to chart his or her own course. A so-called “principle trust,” for example, gives the trustee discretion to make distributions based on certain guiding principles or values without limiting beneficiaries to narrowly defined goals. But no matter how carefully designed, an incentive trust won’t teach your children critical money skills.
Put on your teacher’s cap
There’s no one right way to teach your children about money. The best way depends on your circumstances, their personalities and your comfort level.
If your kids are old enough, consider sending them to a money management class. For younger children, you might start by giving them an allowance in exchange for doing household chores. This helps teach them the value of work. And, after they spend the money all in one place a few times and don’t have anything left for something they really want, it teaches them the value of saving. Opening a savings account or a CD, or buying bonds, can help teach kids about investing and the power of compounding.
For families that are charitably inclined, a private foundation can be a great vehicle for teaching children about the joys of giving and the impact wealth can make beyond one’s family. For this strategy to be effective, children should have some input into the foundation’s activities.
Consider trust distribution amounts
In addition to teaching your children about money management principles, it’s important to give them practical experience so they can learn from their mistakes. Unfortunately, many parents take an all-or-nothing approach, either transferring substantial amounts of wealth all at once or making gifts that are too small to provide meaningful lessons.
Trust distributions should be large enough so that your kids have something significant to lose, but not so large that their entire inheritance is at risk. For example, if your child’s trust is worth $2 million, consider having the trust distribute $200,000 when your son or daughter reaches age 21. This amount is large enough to provide a meaningful test run of your child’s financial responsibility while safeguarding the bulk of the nest egg.
Spell out your plans
Your estate plan can be a powerful teaching tool, but only if your children or other beneficiaries understand the lessons you’re attempting to impart. To avoid hurt feelings — or even litigation — it’s important to discuss your plans with your family.
For example, if you set up an incentive trust for your children, communication is critical to ensure they understand your motivations and the values you’re trying to reinforce. Or perhaps you’re limiting your children’s inheritance so they can make their own way, providing nothing more than a financial safety net so they won’t end up on the street if they fail. Or maybe your plan encourages financial success by making matching gifts equal to the amount of income your children earn each year.
Whatever approach you choose, ensure that everyone in the family is on the same page. There are many ways to achieve this, including informal discussions, family letters explaining your intentions, structured family meetings and family mission statements.
Make your legacy last
If you plan on leaving a sizeable amount of your estate to your children, including an incentive trust in your estate plan can be a good idea. But it’s also important to pair the trust with a plan to educate your children about money management skills, including saving and investing. Doing so will increase the chances there will be money left to pass on to your grandchildren.