Maximizing the Benefits of Inherited Wealth

Reprinted with permission of Michigan Lawyers Weekly

By John E. Mayer

Here’s a riddle for you. The first generation makes it. The second generation holds it. The third generation spends it. And the fourth generation strives to make it again. What it is it? Money.

The problem with money is that when it is inherited, it often is not fully appreciated. Most people believe that a family inheritance should provide opportunity to those who benefit from it. The problem is that all too often, money that is inherited simply supports the lifestyle of those who remain behind. This results in a negative impact instead of a positive one.

In an effort to maximize the benefits that wealth can confer, many people are exploring new and exciting alternatives. One of these is Charitable Trusts. Another is the family incentive trust. Both have the potential to dramatically confer benefit on whomever the client chooses.

Trust Options

Charitable trusts enable donors to earmark a significant amount of wealth from their estates for philanthropic purposes that support causes they believe in. In effect, the charitable trust is funded by monies, which would otherwise revert to the government through estate taxes.

Charitable trusts are an excellent way to channel money for philanthropic purposes—particularly when accumulated wealth far exceeds what the family could possibly want or need. Family members can be appointed as trustees who can draw a salary for their efforts on behalf of the trust. They also have the opportunity to travel in circles where connections can be made to benefit their businesses.

The other vehicle, the family incentive trust (FIT), is a “dynasty” trust designed to exist across generations of the client’s family. It can potentially minimize the adverse impact of inherited wealth. The FIT is used to:

· provide a safety net for family members;

· encourage and reward responsible behavior; and

· serve as a source of investment capital and loans.

The client specifies what needs and/or positive behaviors the trustees should respond to. The positive impact inherited funds can make under such a program is truly exciting.

Impact of Wealth

Drs. Thomas J. Stanley and William D. Danko have studied people and the accumulation of wealth for more than 20 years. In their best selling book, The Millionaire Next Door, one of the issues they examine is how wealth accumulated by parent’s impacts on their offspring.

Parents who have demonstrated significant skill at accumulating wealth earlier in their lives are often in a position to distribute “economic outpatient care” (EOC). These parents may have been frugal when addressing their own needs but wish to shower their children and grandchildren with “acts of kindness” in the form of economic support.

There are many forms of EOC. Some have strong positive influence on the productivity of the recipients. Others can be detrimental. Positive uses for EOC include subsidizing children’s education and earmarking gifts to start or enhance a business. The giving of non-cash gifts allows the parent to have control over how funds are spent.

Cash gifts, on the other hand, are most often used to prop up one’s lifestyle. These gifts are the single most significant factor leading to lack of productivity among adult children of the affluent. Cash gifts often affect the recipient’s psyche resulting in a decrease of initiative and productivity. They become habit forming—almost like a drug. The recipient may develop a lifelong dependence.

From their survey Stanley and Danko’s conclude that:

· giving precipitates more consumption than saving and investing;

· gift receivers in general never fully distinguish between their wealth and the wealth of their gift-giving parents;

· gift receivers are significantly more dependent on credit than non-receivers; and

· receivers of gifts invest much less money than non-receivers.

Author John Sedgwick explores what happens to those “lucky souls” who strike it rich at birth in his book, Rich Kids. He interviewed 57 young heirs and heiresses to America’s greatest fortunes who started their lives at the apex of the pyramid that everybody else spends a lifetime climbing. Only one of them had any real success he could call his own. The others were always living under the shadow of their elders. They were prisoners of wealth—often plagued with ignorance of money matters, spending sprees, guilt, mad passions and an unending search for happiness in work. They had no connection between what they had done and what they have received. Good fortune can be as disruptive as tragedy.

Real Life Examples

A May 19, 1997 article in Forbes titled “The Disinheritors” gives examples of successful people who have decided to help their children have productive lives by donating the bulk of their wealth to charity.

Construction engineering magnate Joseph Jacobs, who is the son of poor Lebanese immigrants, decided with his wife, Violet, to empower their three daughters. “Because we love you very much, we have decided that we are not going to leave you a lot of money,” they were told. Each received $1 million dollars of stock in Jacobs Engineering in 1971, and while it has appreciated in value, this represents only a small portion of their parents’ wealth.

Jacobs, now 80, has not changed his mind. “One of the worst things I could do, is indulge them to the point where they don’t have the opportunity to make their own failures and successes that they can say are theirs and not their parents,” he said.

In addition, Home Depot Chairman Bernard Marcus agreed that inheritances can be a “terrible burden for some.”

“If my kids want to be rich, they’ll have to work for it,” he said. He plans to leave almost all of his $850 million in Home Depot stock to the Marcus Foundation, which supports education and the handicapped.

Meanwhile, Telecommunications Inc.’s John C. Malone doesn’t believe his kids want a lot of money. “I think your kids are destroyed by too much wealth, not enhanced by it,” he explained. Malone and his wife, Leslie, and their two grown children aren’t interested in the burden of being super rich. Instead, they support the idea of a charitable foundation that they can oversee as trustees.

“Many wealthy people crush their children inadvertently,” said billionaire Herbert A. Allen of the investment banking firm, Allen & Co. “If you’re the child of a wealthy person and your first paycheck is totally meaningless, you’ve had something taken away from you.”

And Warren Buffett said that, “parents should leave children enough so they can do anything, but not so much that they could do nothing. Giving heirs a lifetime supply of food stamps just because they came out the right womb can be harmful for them and is an antisocial act.”

Psychological Studies

The Whitman Institute coined a term they call, “affluenza” — which refers to the liabilities attached to inherited wealth. “The money that buys power, privileges and luxuries can just as easily damage a child’s self-concept and motivation to achieve — [with] a range of symptoms: immaturity, boredom, selfishness, lack of self-discipline, alienation, aimlessness, rebelliousness and suspiciousness.”

Further, psychologist Martin E. P. Seligman conducted an experiment with caged rats. He taught one group to push down on a metal bar by rewarding their successful efforts with a few pellets of food. Another group of caged rats was showered with pellets of food from the top of the cage although these rats could also obtain food by pressing the bar. The first group eagerly worked for its food while the second sat around looking up at the ceiling. Rats who had a task to perform for their food were happier. Rats in the second group were frustrated that they couldn’t control events though their own actions.

Seligman wrote, “What produces self-esteem and a sense of competence, and protects against depression, is not only the absolute quality of the experience, but the perception that one’s own action controlled the experience. To the degree that uncontrollable events occur, whether traumatic or positive, depression will be redisposed and ego strength undermined. To the degree that controllable events occur, a sense of mastery and resistance to depression will result.”

In the animal kingdom, the mother raises her cub until it is able to fend for itself. Then she leaves and lets it make its own way in the world with no help except its early training. Empowerment works in nature. Empowerment works with people.

Conclusion

Earned money is clearly one’s own, an affirmation of talent, energy and self.

An inheritance is none of these. Instead of being a source of pride, it is a subject of embarrassment; instead of rewarding accomplishment, it fosters sloth; instead of belonging to you, you belong to it. People need a sense of accomplishment to be fulfilled.

Should money be left directly to children? Should it all be left to them or should some of it be channeled to charitable causes? There are choices. A charitable trust can be established, or monies left to family members can be controlled through a FIT that will encourage positive behaviors and help the children become individuals who contribute to society. It is clear that the next generation must be prepared for inherited wealth. It may be a mistake to just leave it. Therefore, clients must have their estates planned carefully.

Estate planning choices enhance the probability that the children will become economically productive. In addition to providing the resources for an education, clients can create an environment that honors independent thoughts and deeds, cherishes individual achievement and rewards responsibility and leadership.

By taking advantage of charitable trusts and/or a FIT, clients can minimize the adverse impact of inherited wealth, and ensure the money left to the family is used for productive purposes and the greater good in the community can be supported.

Now is the time to clarify your clients’ values to determine how their heirs can be best served by the estate and leave the legacy of their values to those they care about most.

Bio: John E. Mayer is president of BFA^® Family Wealth Planners, a registered investment advisor firm with offices in Livonia, West Bloomfield, Ann Arbor and Naples, Fla. With more than 20 years of experience in estate and financial planning, the firm specializes in counseling closely-held business owners and high net-worth individuals in various tax strategies. Mayer is part of a nationwide network that works with legal and CPA firms. He can be reached at (800) 452-4983.