When I think of building family wealth, trust funds and inheritances are the first things that come to mind. What else is there?
When Dr. Jim Dahle contemplates a family dynasty, he’s got a lot more than trusts and inherited money in mind. There are many things one can do while alive to enhance the wealth of future generations.
Follow the principles outlined below, and you can be sure to set up future generations with more money than you had, and hopefully, a better idea of what to do with it. However, there’s only so much you can do to ensure they use it wisely.
Making money last throughout many successive generations is a far more difficult task, but that’s beyond the scope of this article. Let’s see what you can do to help your kids and theirs. This post was originally published at The White Coat Investor.
Creating a Dynasty: Building Family Wealth Across Generations
Families are awesome, especially when they can work together toward common goals. In fact, the ability of generations to work together can be a true wealth-producing machine.
It requires a very long-term view, excellent family dynamics, and a little bit of education and “starter wealth,” but if done properly, it can be far more powerful than any other personal finance concept.
If generations are willing to “cover” each other, they can increase their ability to take risk, decrease their need for expensive insurance-based solutions and decrease interest paid. Let me give you a few examples.
11 Ways to Build Family Wealth Across the Generations
#1 Youth BackStopping Retirement Savings
In decades past, there was no such thing as retirement. People worked until they no longer could, and then their kids took care of them until they died. Or until they took them out on the ice to die. Or whatever.
Now that it is apparently a sin to rely on your children, people put a lot more effort into supporting themselves in their retirement years. But because they have to be self-sufficient, they cannot afford to take risks that they otherwise could.
Instead of investing in risky assets with a high expected return, like stocks or real estate, the elderly are forced to diversify into bonds, CDs, and immediate annuities to ensure they don’t run out of money.
However, if their children could provide the “insurance” against them running out of money, the elderly could not only have a higher withdrawal rate, but could also afford to take more market risk with their portfolio.
How do the kids provide that insurance? Simply by being willing to let the elderly live with them or help with their living expenses from their current earnings. Another way to help would be by allowing the elderly to delay taking Social Security until age 70 by helping with living expenses until that time.
#2 Paying For College/Homes
Now, let’s look at a way the older generation can help the younger generation. One of life’s most expensive decades is the 20s.
You have very little earning ability but lots of needs including an automobile, a college education, perhaps a wedding, and most importantly, a first home. Due to a lack of cash and earning ability, young people end up borrowing a great deal of money for these things, and not always at the best possible terms.
The more of this stuff that the older generation can pay for, the better off the family as a whole will be. In fact, it’s even possible that the debt for one generation could be the income for another.
There are IRS rules about how much interest must be charged, but when combined with gifting allowances, it’s relatively easy to provide excellent terms on family loans.
Imagine being debt-free at 30. No student loans. No car loans. No credit card loans. No mortgage. You come into your peak earnings years and can immediately start saving for retirement and your own children’s college. Instead of the family paying interest, the family is earning interest.
#3 Taking Advantage of the Step-up In Basis
One of the greatest gifts from the IRS is the step-up in basis that your heirs get on your assets upon your death. A great deal of estate planning can be done around this simple rule.
Many times, if two (or three) generations work together, a family can avoid realizing a capital gain and allow that step-up to occur.
For example, grandpa needs some money and the only way to get it is to sell the family farm. That sale will generate a $2 million capital gain.
It would be far better for the kids to provide grandpa the money he needs out of their own earnings or savings and wait for him to keel over to sell the farm. More money for each family member. The same thing can be done with stock portfolios, the family home, or the lake cabin.
#4 Gifting Rules
The gifting rule is a fantastic way to avoid paying estate taxes. In fact, it seems silly for anybody beyond the ridiculously wealthy to ever pay federal estate taxes when it is so easy to avoid them.
Imagine an elderly couple with an estate tax problem (a growing portfolio > $10 Million). They want to pass as much of that portfolio on to their heirs as possible. Well, how much can they pass each year?
They can pass $15K each to each of their heirs. So let’s assume they have 4 married children, each of whom has 4 married children each of whom has 4 unmarried children. That’s a total of 104 heirs. $15K*2*104= $3.12 Million per year that can be legally moved from the portfolio to the heirs — estate and income tax free.
#5 What About the Generation Skipping Tax?
If you keep the annual gifts to $15K or less, the estate tax exemption ($11.4M per person in 2019) also applies to generation-skipping taxes. Just use annual gifts to reduce the size of the estate.
In general, if there is no estate tax due, there should be no generation-skipping tax due. However, keep in mind the portability of the estate tax exemption between spouses does not extend to the generation-skipping tax. If you are a couple is in the $11-23M range, meet with an estate planning attorney in your state for some special planning.
#6 Stretch Roth IRAs
One of the greatest gifts you can be left is a Roth IRA. It’s even better if that gift is left to someone quite young because the required minimum distributions are based on the age of the heir.
It’s possible for a Roth IRA to allow tax-free compounding for over 150 years if done properly, at least until/unless the SECURE Act in Congress of Fall 2019 is passed which will limit the stretching of Roth IRAs to just 10 years.
In order to maximize family wealth, it’s best to leave these valuable assets to the youngest person possible. While a stretch traditional IRA isn’t quite as nice (since taxes are due on the withdrawals) it can still allow tax-protected growth for many additional decades if left to the right heir.
[Update 10/2019: Congress is discussing a bill that would limit stretch IRAs to just ten years of stretching before the balance would have to be withdrawn. It seems somewhat likely to pass.]
#7 Paying for Education
Just like it’s best for the high earner to claim his college student as a dependent on his taxes, so is it best for the tax deductions to be concentrated in those who are earning the most. Education credits are far more valuable that way. Thus, the rich generation should pay the tuition bill. If they’re not able to truly cover it, the younger generation can gift them the difference.
Likewise, parents may not be able to max out 529 contributions upon the birth of a child, but the grandparents might be able to — extending the period of time that assets grow in a tax-protected way. The result — fewer taxes for everyone.
#8 Estate Planning
There are many other great ways to pass money from the older to younger generations, including irrevocable trusts, spendthrift trusts, etc.
It would be an estate planner’s dream to have multiple generations of people who all get along with each other walk into her office and ask how best they can maximize their assets by working together.
#9 Asset Protection
Assets can also be protected from creditors by moving them from those with the highest risk to those with lower risks. Many docs already do something similar by titling the cars, boat, and house in their spouse’s name.
Why don’t more people do this? Because they don’t trust each other. Overcome that hurdle and all kinds of things are possible.
#10 Reduced Insurance Costs
The faster the next generation becomes wealthy, the sooner they can stop paying for unneeded disability and life insurance. Longevity insurance and long-term care insurance premiums can also be saved, further building family wealth.
#11 Teaching Financial Principles
The most important thing that multiple generations can do in order to maximize family wealth is to pass along the knowledge and values that allowed that wealth to accumulate in the first place.
Most of us enter our 20s armed only with the financial knowledge taught to us by our parents’ examples. Dedicated time spent teaching financial principles, both by example and more formal methods, can pay incredible dividends.
Teach your children to work, earn, save, invest, spend, and give wisely and you will have done much to increase and protect the family nest egg. If each generation views themselves as stewards of the family wealth, charged with preserving and growing it for the next generation, only good can come of it.
Do you plan to pass wealth on to your children or grandchildren? Will you do so while alive or as an inheritance? Which strategies do you plan to implement?
4 thoughts on “Creating a Dynasty: Building Family Wealth Across Generations”
Wonder what Lizzie Warren would think of this?
We avoid the economic outpatient care issue (we hope) by only offering to gift an amount equal to what goes into retirement savings (up to gift tax limit). Both older kids have 403 and govt 457 so they can stash all $30K we gift. They won’t spend it as they are both natural savers, but it will be there if they lose their job (457) or at retirement – so now they can focus savings on emergency fund, house down payment, etc.
Good strategy ArmyDoc. Sounds like you have done a great job with #11! My daughter came home for the Thanksgiving holiday and asked if she and I could sit down to review her finances and investment elections now that she is a few months into her first job after college. When I suggested that she could swing getting her own apartment next year instead of dealing with minor roommate issues, her response was “No, I don’t think so yet. I’m just too frugal.” Music to her father’s ears 🙂
Very good summary, Jim. Giving yearly cash gifts to heirs, however (especially to adult children), reminds me of the perils of “Economic Outpatient Care” described so well over twenty years ago in The Millionaire Next Door. I have seen this play out firsthand in family members who ear mark such gifts for immediate consumption to support a lifestyle that they otherwise could not afford, leading to all manner of problems. Likely the first place extra funds will be given in our situation will be things like 529 contributions for grandchildren. Strongly agree that #11 above is the best possible financial “gift” one that one can give one’s heirs. The earlier in life these lessons begin, the better. Happy Holidays to all!