Finance & Investment: Loosening the Purse Strings
Giving some of your wealth to your children is easy, but as one father and son learned, giving it smartly can be difficult. On his 18th birthday, a young man received the entirety of his trust—no strings attached—from his father. Seven years later, though, with less than half of the assets remaining, the man blamed his lack of prudence on his father. In a letter to his father, he admitted that he spent more money than he should have, though he added, “That is mainly your fault because you gave me the money, but you didn’t give me any guidance.” Stung by his son’s criticisms and lack of gratitude, the father, who created the family’s wealth in the software industry, wrote back that it never occurred to him that his son would have difficulty handling money.
Now, in his 30s, the son says he is trying to exercise some self-control. “There’s a golden principle I’m trying to obey, which is never spend the principal,” he says. “I love having money, and I think he didn’t give me enough, but it has been hard to learn that kind of discipline when money has always been there.”
Giving a large sum of money to an 18-year-old or even a 21-year-old can be precarious under the best of circumstances. Early adulthood is a naturally difficult time because a dependent child is maturing into a self-supporting, autonomous adult. This transition can be made even more difficult when parents tell the child that it is time to go out into the world, find a job, and be a grown-up while simultaneously giving him or her enough money to live on. One way to pass on and preserve family wealth, without destroying your child’s motivation or burdening him or her with managing a tremendous sum of money, is to create a trust fund.
Some young people are unable or unwilling to learn how to manage money, and for them, a trust is the only sensible option other than giving them no money at all. A smaller number of young adults are naturally prudent with money, but most are somewhere in the middle. Generally, experts advise that you give your children as much money, and as much control over it, as they are able to manage responsibly. By the time children reach adulthood, you should have a fairly good idea of what sums your children are capable of managing. One way to help get children thinking about managing their own finances is to get them involved in the family’s foundation, says William H. Forsyth Jr., managing director and senior fiduciary counsel at Bessemer Trust, a company that has been managing wealth for nearly 100 years. “Foundations also have a portfolio,” he says. “It’s not their money directly, but they are responsible for it.”
The question is: How do you structure trusts if your children differ greatly in their abilities to manage assets? “I think it’s dangerous to set up trusts with each child in mind; there are already enough issues among siblings in every family,” says Forsyth. “Parents are puzzled about what to do. So if one child needs property protected in a trust, they tend to treat all the children that way.” He is quick to clarify that structuring trusts the same for all children does not mean that each child should be treated the same by the trustee. You may want to strictly limit the power of the trustee to authorize distributions of principal if, for example, you have a mentally impaired child. If you have another child who handles money wisely, you may stipulate distributions of principal to pay for graduate school, purchase a home, or launch a business. In those situations, you need to include enough flexibil-ity in the trust so that the trustee can use discretion when the beneficiary asks for distributions of principal.
If you decide to give away part of your wealth now, experts suggest creating a living trust to distribute income and/or assets during your lifetime and beyond. The two types of living trusts—revocable and irrevocable—can vary widely in effect depending on how they are written. A well-crafted revocable trust is designed to end or dissolve at a certain point in the beneficiary’s life, such as when he or she turns 30 or purchases a house.
At that time, the beneficiary assumes complete control of the assets in the trust. Thus, it protects your children from their own ig-norance and youthful foolishness, as well as from predatory “friends” and suitors, without undermining the opportunity for them to develop autonomy. Revocable trusts, how-ever, often do not qualify for tax benefits for the grantor.
Creating an irrevocable trust, on the other hand, is much riskier because the person or institution you choose as the trustee will be in a position of power over your children throughout their lifetime. An irrevocable trust cannot be changed or terminated by anyone—including the grantor. That does not mean, however, that you should avoid forming an irrevocable trust. The imperative is to create the trust with as much flexibility as possible. Lynn Getz-Schmidt, director and vice president of her family’s real estate concern and executive director of her family’s foundation, created an irrevocable trust shortly after her daughter was born.
The trust’s wording is purposely broad so that when the girl reaches college age, she can request distributions for educational purposes. “If a parent mistrusts her child and creates a tightly controlled trust,” says Getz-Schmidt, “on some subconscious level, that parent doesn’t trust her own parenting skills.”
One type of irrevocable trust that is gaining popularity is called an incentive trust, which requires the beneficiary to reach predetermined goals, such as college graduation, to receive part of the family’s wealth. The idea is that an incentive trust will inspire children to be goal-oriented; however, some perceive these trusts as little more than bribes that enable parents to control their children even after death.
Some incentive trusts state that the trustee can pay a beneficiary an equal amount of money to what he or she earns. “Think of the worst scenario,” cautions Forsyth. “What about the case of a disability, an at-home parent, a schoolteacher, or a museum curator? You’re saying money is your highest value, but [parents] have a fear of children being spoiled, so they want to lock up the money.”
Make Your Intentions Clear
Once you decide to create a trust, your estate attorney and financial planner should help you define the goals and values you want to encourage in your child, such as a formal education, a career, or philanthropy. If you do not discuss in depth what specific principles to incorporate in the trust, it is likely that the final trust will reflect the attorney’s desires, not yours. For example, your attorney may assume that it is important that children complete advanced degrees or stay single until a certain age.
No matter what is important to your family, write plenty of flexibility into the trust—even if it has been carefully thought-out, circumstances can change. The value of the trust, for example, may grow exponentially through wise investments, but if the trust is too stringent, your child may never be able to access the principal. If you gift stock in your business to your child year after year, for instance, its value may mature more than you anticipated. The bottom line, says Forsyth, is that you do not want to be bound by an instrument that does not fulfill your intentions. This is the time to take advantage of the judgment, experience, and expertise of your advisers.
Although most parents keep mum about their child’s inheritance until just before the assets are distributed, experts don’t recommend doing so. The re luctance may be because of squeamishness over talking about money, a fear of triggering their child’s greed and fi nancial recklessness, a desire not to lose control of the money, or simply not knowing what to say. “My feeling is that there’s a time when my children will be ready to learn about what they will inherit,” says one parent, “and telling them before they’re ready isn’t going to do much good.”
It is important for you—not your attorney—to explain to your children why the trusts were structured the way they were, says Forsyth. “They can disagree [with the terms of the trust], but they are angry at their parents, and that’s where the anger belongs,” he says. “It’s a bad idea to end up being mad at your siblings or trustee.” Getting firsthand knowledge of the grantor’s intent diminishes the opportunity for arguments about what mother really meant when she placed the vacation house that everyone loved in a trust. “Parents need to talk to everyone. It helps keep the family together.”
One gentleman learned of his inheritance from a family lawyer because his parents were uncomfortable talking about money. “It was a completely discombobulating experience,” he says. “The knowledge that I had [a trust] was debilitating for some time. I got involved in foolish financial ventures and drug abuse. It took me a long time to find my way out.”
Such a reaction is common, says Dennis Pearne, a clinical psychologist and wealth counselor in Boston with more than 20 years of experience. “The moment of actually receiving wealth is often so shocking that therapists may see post-trauma [symptoms] associated with the event years later,” he says. Coming into large amounts of money, especially when a young adult has not been properly prepared, can cause disorientation, depression, and anxiety.
Choosing a Trustee
Especially in the case of long-term trusts or irrevocable trusts, choosing a trustee is one of the most critical decisions you will make. A trustee can be a family member, an attorney, or an accountant, or you may choose an institutional trustee—a trust company or a trust department within a bank. “It’s called ‘trustee’ for a good reason,” says Forsyth. “[The assets] need care and attention. Especially now—it’s a difficult time to be investing. You want at least some access to professional management.”
Institutional trustees are more common than individual trustees, but they are only as capable as the financial institution and the officer who administers the trust. Some trust officers are exemplary and see their role as not only the gatekeeper of the wealth, but also as educator, mentor, and guide while investing the assets and allowing them to grow in value.
Several years ago, the owner of an international pulp and paper company struggled unsuccessfully to teach financial responsibility to his daughter while managing her assets. “I didn’t have any sense of budgeting,” says the now-adult daughter, adding that she never had a sense of what spending too much money meant. “Finally, when I turned 30, Dad decided to turn me over to a trust officer, and little by little, and somewhat painfully, he taught me to live on a budget. For the first time, I felt like I was in control of my life.”
Some trust officers may be poor communicators, incompetent, or dishonest about how the funds are being invested and sold. However, even when flagrant incompetence, such as gross mismanagement of the funds or outright theft, occurs, it is difficult and time-consuming to hold the financial trustee accountable.
The worst instance of a bad trustee, Forsyth recalls, involved a family in which none of the trustees were members of the family. The family tried to remove the corporate trustee—which they believed was not acting in their best interest—but the case was tied up in litigation for many years, costing the family millions of dollars in lawyers’ fees. “You really don’t want to get stuck with a person forever,” Forsyth says. “Build in a method by which trustees can be changed. Consider a protector to oversee the trustee. It’s important that the family has control of who the trustees are.” Choosing a close friend or relative as your child’s trustee invites other potential problems. That person cannot be entirely impartial. Family dynamics and physical distance can also complicate the relationship.
Advice on how to create a trust is summed up in two words: priorities and control. You need to decide which is more important: preserving as much of your wealth as possible for as long as possible or allowing your children to take ownership of the wealth once they are ready. “Parents who think about trusts carefully don’t say, ‘I want you to become CEO and make a zillion dollars,’ ” says Forsyth. “What they say is, ‘I really care about you, and I want [to help] you to lead a productive life.’ ”
Minors and Money
The annual gift tax exclusion was increased by $1,000 at the beginning of 2002 so that a person is now allowed to give $11,000 tax-free to a single recipient until he or she reaches adulthood. That means that, from you and your spouse combined, each of your children can collect $22,000 a year in cash, stocks, and other assets.
The Uniform Gifts to Minors Act (UGMA) allows minors to own securities, and the Uniform Transfer to Minors Act (UTMA) broadens the scope of gifts to children to include such assets as real estate, art, and royalties. Both are similar to trusts in that they are ways to gift assets to children; however, both acts are written into the law and do not require drafting a document or hiring an attorney. A custodian or trustee holds the assets until the child becomes an adult in the eyes of the state, at which time the custodian is required to distribute all of the assets. To prevent your child from cashing out the assets, you can have him or her voluntarily sign a short-term trust instrument that allows you to temporarily control how the assets are distributed.
Barbara Blouin, who is the beneficiary of a strict irrevocable trust, understands well the caveats of creating trust funds and the stresses those decisions place on families. She is the cofounder of The Inheritance Project (www.inheritance-project.com), an organization formed 10 years ago to explore the emotional and social impact of inherited wealth. She has interviewed more than 200 inheritors during research for her two books and three booklets on inheritance, including Coming into Money: Preparing Your Children for an Inheritance. “One woman I interviewed figured [out how to handle the money] really fast, but she’s the exception,” says Blouin. “The norm is that people don’t know what to do.”
Although Blouin admits that there is no universal golden advice because each child is different, she does offer some guidelines to consider. “If you haven’t had the experience of supporting yourself, then there is an important component that you’re missing,” she says. “Some people have low self-esteem because they never worked, and they feel like they are not like other people. There’s a lack of confidence that you can take care of yourself, and the longer it goes on, the harder it is to muster whatever it takes to go out and get a degree. A lot of people never do that, and I [have seen] a lot of sadness and waste.”