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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.
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.
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.