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A TOPIC THAT’S been in the news recently is the so-called K-shaped economy.
Imagine a chart plotting the relative standing over time of those with higher incomes and those with lower incomes. Owing to a strong stock market and rising home values, the shape of the chart for those with higher incomes would extend up and to the right and has been moving increasingly in that direction since Covid.
Folks with lower incomes, on the other hand, haven’t benefited as much from rising markets. Instead, they’ve had to contend with higher prices on key budget items, including housing, tuition and healthcare. For this group, unfortunately, a chart of their financial progress would extend down and to the right.
Put these two charts together, and they form a K—hence, the K-shaped economy.
Because this divide has been especially pronounced for young people, more parents are asking how they can help their children. But they aren’t always sure of the best way to approach this.
You may have heard the story about the late Charlie Munger. Some years ago, a friend asked Charlie if he planned to leave his considerable fortune to his children. Specifically, his friend wondered whether too much wealth would impact his children’s work ethic.
“Of course it will,” Munger replied. “But you still have to do it.”
“Why?” his friend asked.
“Because if you don’t give them the money, they’ll hate you.”
On the one hand, this is funny, but it also gets at why this topic can be so difficult. In fact, I’ve often referred to it as the hardest question in personal finance. But it isn’t impossible. If you’d like to help your children—either today or as part of your estate—here are four questions I suggest considering as you develop your plan.
1. What problem are you most trying to solve?
Some families are clear that they just want to help their children as much as they can today, to combat the challenges of the K-shaped economy. Other families are focused on the long term and just want to see their assets pass to their children tax-efficiently at the end of their lives. Both are reasonable objectives, but it’s important to have clarity on what’s most important to you as the first step.
2. To what degree do you value simplicity over tax savings?
With the federal estate tax at 40%—and many states levying their own taxes on top of that—folks with assets above the lifetime exclusion often conclude that it’s worth spending virtually any amount on legal fees in an effort to defray that tax.
But not everyone agrees. Other families see it this way: While estate planning strategies can be effective in reducing taxes, they can be costly to set up and to maintain. For that reason, other families decide to spend little or nothing on estate tax strategies. They accept that their estates might—and likely will—end up facing a larger tab at the end of the day. But, they argue, if their estate is large enough for the estate tax to apply, then by definition, their heirs will nonetheless still receive a significant sum.
3. Do you worry about the problem Munger’s friend highlighted?
If you’re worried about impacting your children’s work ethic, then counterintuitively, it may make sense to start making gifts sooner rather than later. The key is to make modest gifts and to make them incrementally.
When you start making gifts like this sooner, it can serve two purposes. As a parent, it gives you the opportunity to see how your children handle these smaller sums. Do they immediately head to Bora Bora, or do they save and invest the dollars they receive?
Making gifts incrementally can also help the recipient. To the extent that the first—or the second—gift is spent frivolously, modest gifts provide children the opportunity to acclimate and hopefully to adjust.
4. To what degree would you like to control your children’s use of assets down the road?
If you go the route of an irrevocable trust and plan to leave assets to your children as a bequest, you won’t have the opportunity to iterate in the way I described above. That said, you may still prefer to leave assets to your children in this way.
The key challenge with trusts is how to structure the distribution provisions. Put too many restrictions in place, and you risk causing your children a lifetime of stress or, worse yet, resentment. But put too few restrictions in, and the trust assets could be spent unwisely and deplete too quickly.
How can you thread the needle? There’s no single right approach, but here are four distribution strategies you might consider.
Based on age or stage: You might stipulate, for example, that a child reach age 30 before receiving any funds. Or you might require that a child have finished college or be married before receiving funds. The benefit of this approach is that it doesn’t leave room for debate between your children and the trustee. The downside is that this sort of structure can be too rigid, because children’s needs don’t always align with specific ages or stages. The reality is that everyone takes different paths through life in ways that no formula can fully contemplate. I often reference the movie The Bachelor, which is a comedy but illustrates how an overly rigid structure can have unintended consequences.
Annual percentage with no discretion: This structure also has the benefit of being straightforward, with no room for debate between beneficiaries and the trustee. In addition, a fixed percentage can help preserve a trust’s assets for many years. The downside is that children’s needs typically vary from year to year. They’ll want to buy homes and may have tuition expenses for their own children. For those reasons, a fixed percentage, while attractive in theory, runs the risk of being an obstacle to your children’s most important goals.
Annual percentage with an override for specific needs: The benefit of this structure is that it provides flexibility if a child wants to buy a home or has other higher-than-normal expenses in a particular year. The downside is that it opens the door to debate between beneficiary and trustee. The trustee might deem a proposed home purchase too expensive, for example.
Trustee’s discretion: A final approach is to leave distributions entirely up to the trustee. That’s the most flexible but also the most potentially fraught. If a trustee and a beneficiary don’t get along, this setup would give the trustee wide latitude to make the beneficiary’s life miserable for decades. No distribution structure is perfect, but it’s for this reason that I tend to recommend against this approach, common as it is.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
Given modern lifespans, it is likely that many of those receiving inheritances will already be retired, and have substantial assets of their own. Work ethic? Well, not applicable if you don’t work any more.
I would not angst over distribution plans too much. Keep in mind that they are receiving money that they have no entitlement too, that many of us never received. So mana from heaven regardless of how it is distributed, whether it fits their life plans or not. I would have been glad to receive any inheritance, however it was distributed. Beats zero. Anyone bitter about an inheritance, likely does not deserve it.
My children are beneficiaries of my trust which will become irrevocable when I die. It has instructions for distribution of trust assets to them. A nagging concern I have is the ability for beneficiaries of an irrevocable trust to change provisions of the trust, as long as doing so does not violate the material purpose of the trust, and as long as all beneficiaries agree. This can be done through a nonjudicial settlement agreement, a mechanism under the Uniform Trust Code adopted with variations in most states. One’s trust instructions are not ironclad. But, I still think its better to have a trust than not have one.
Always interesting articles, please keep them coming Adam. Thanks for all the ideas.
Work ethic is important in my view for several reasons. Builds character, empathy and connection for and with the fellow man. Few people have the means to not work so you’ll have fewer people to connect with should you not, but one can always find his/her tribe. Plus it can fuel the spirit knowing that you can achieve certain goals and make you self sufficient and resilient knowing you can always roll up your sleeves and dig yourself out of any hole with your efforts .Also once you know how hard it can be to make money, you appreciate it more and waste less. Age and personality also matters. One kid may be a good steward with funds while another will blow through it. I’d suggest accounting for age and experience, maybe releasing funds at specific ages …at age 21, 25 percent, or age 26, 25 percent, age 30, 25 percent and then all remaining funds at a final age. with provisions of course for specific milestones, graduating college , purchasing house, marriage etc. Like all things there is no one strategy that works as everyone’s means, resources and situations are different. Anyone receiving funds from inheritance should be grateful, no matter if it’s provided periodically and over time. There are many people who are left nothing and is common in certain communities. Thanks again for the information and articles that you share!
How to share wealth with family depends on many variables, including where they are now in their work-lifecycle. Our sons are in their early 40s and have six children altogether. I favor sharing some with them now, via strategic gifting to help them achieve financial stability. And of course, 529 plans for the grandchildren. After we are gone, a nice inheritance will help them to do the same for their children.
Adam point outs out there are many ways to set up trusts to distribute assets to children or grandchildren, and every family’s circumstances are different. But first you must decide if you prefer to have your children inherit your assets when you die or help them out while you are alive. For me, I will derive no satisfaction seeing the benefits and the impact of my gifts when I am dead. Assuming I die in my late 80s or 90s, and my 3 children are in their 50’s and 60’s, the are likely well past the age of needing funds to have a meaningful impact on their families lives. As such, we have decided to help them while they are younger and building their lives, with assistance on homes, child care, etc. The same goes for charitable gifts, give now and witness the impact while you’re alive,
This is similar to what we do. We helped our kids with their first homes and cars. We helped them through college. We help watch our grandkids now. We haven’t been retired long enough to feel comfortable about giving them yearly gifts yet, but hope to be in that position in a few years. Those of us who can help our children in these ways are blessed, not everyone can do this. Chris
I’ve seen the suggestion of a trust paying out sums equal to 1, 2, or more times the annual earnings of a child or grandchild post high school or college. This gives them the option of working in a less lucrative field they love, or putting more of their earnings into a Roth IRA early in their career.
Great article Adam. The K shaped economy is now beginning to have a large effect on our politics. I also see my adult children dealing with the effects of much higher home prices. They all make a living wage and can afford homes where they live, however, it’s a lot harder for them than when I was in my 20s. Basically, you need to own the right kinds of assets going forward or the debasement of our money/inflation will keep you on a treadmill forever.
A huge help is paying for college or for professional training so that the kids start off debt free. I think we all agree that no debt means less stress,more agency, and a foundation for building wealth.
As a general issue, I don’t believe that having money damages work ethic. It’s not having a work ethic that leads to not working. In my experience, since I was a little kid growing up along side some very wealthy classmates and now as an educator, and just by looking around, how hard people work is not correlated with pre-existing wealth. Also, why is the idea of working for money considered such a virtue even when you may not need to do it?
This comment in another article here addresses an aspect of this:
https://humbledollar.com/forum/the-paradox-of-wealth/#comment-2096040
Also, I think we all need to work harder to change the system because the low and high ends of the K are unfair and unsustainable.
You made some good points Cammer Michael.
I thought about your question: “Also, why is the idea of working for money considered such a virtue even when you may not need to do it?”
Munger’s partner, Warren Buffett finally stepped down at 95 as CEO but remains Chairman. He said the ideal amount of money to leave to your children is enough so that they feel they can do anything, but not so much that they could do nothing. Due to his vast wealth, even after taking care of his family, he will have given away nearly all his wealth to charity after he has gone.
I do not envy or resent those wealthier than I, even those who are fantastically wealthier. On this subject, I consider work ethic, fairness and generosity to be virtues. Greed, flaunting or showing off one’s wealth and power, not so much.
Thank you Jack,
I think kids watch and learn by seeing Mom and Dad early on. My 2 boys know I worked until I earned the maximum from SS, over one half a century. Along with doing over time and holiday work, I made a solid wealth base.
I feel wealth is grown by acting in a wealth producing manner to make it grow so, if we know what to do, and do it, we won’t worry about having money.
That’s how the rich get richer generally.
This is learned by the offspring. Neither of my sons has money problems, not because I freely give them money but they, by work ethic and correct actions, are building their own estates.
Any money from my estate will be another layer on their own retirement cake.
Good article. My wife and I have been concerned about helping our 20-year-old daughter develop a good relationship with money since she was a tyke. The effort will probably continue until our death, or until she’s the one giving advice to us.
Our daughter is careful with the small sums in her charge, but as yet has no experience with the task of managing a household on a real income. So, our wills provide guidance to the executor for an incremental distribution of the funds in case we die earlier than expected, just to give our daughter a little time to adjust. It’s not a complicated structure, but it protects a young adult from making a costly mistake with all of her inheritance.
I think that’s a great approach. I did something similar for my youngest two children which expired when they turned 22. I didn’t want them to get a windfall and then make bad decisions with the money.