Sunday, October 24, 2010

Should You Leave an Inheritance to Your Children?

All the inheritance related questions (as almost all questions on this blog) can be viewed from multiple perspectives, as financial, ethical, psychological, etc. For the matter of this post, we’ll not touch the issues related to finances and taxation.

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Inheritance Arrangement and Financial Crisis

Financial Adviser Magazine ran the inheritance related article in their October issue, where it was noted that many parents are saving more of their estate for their own expenses, and shrinking the amount they plan to leave for heirs. But children's expectations of a big inheritance haven't diminished, and advisors are often caught in the middle. They're warning older clients that it's more important to have adequate resources, and emphasizing to heirs that they'll need other sources to fund their own retirements.

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"What we're saying is, 'Don't worry about the kids,'" says Todd C. Ganos, an investment advisor in Carmel, Calif. "You need to make sure you're OK."

Many working-age people, with their own savings shrunk after the financial crisis, may be hoping that an inheritance will save their retirement plans. "People secretly think we'll probably get $1 million or something," says Debra L. Morrison, a financial advisor in Lincoln Park, N.J. "That's wishful thinking," she says. "An inheritance is the last bastion of hope. People are starting to see their financial blocks crumble from under their feet."

As it battered portfolios, the crisis rocked the confidence of many older investors who have in turn reduced their holdings in stocks—and thus their opportunity for asset growth. Facing rising costs in health care and others areas, they will need more of their own money to meet expenses.

Do Competent Kids Need an Inheritance?

While the ability to leave money to your kids becomes even more difficult task in the modern World of struggling economy, raising prices, and unsure Social Security perspectives, there is a basic question you should ask yourself, if your kids really need you money. You may think that this question sounds really stupid: who does not need money? But if you think twice, the answer may not be so straightforward, as it looks like.

Competent children don't need an inheritance, and incompetent children don't deserve one. In other words, if you have truly taught your children how to fish, they can find their own way; otherwise, placing significant wealth in their hands can be irresponsible and disastrous. While this is certainly a pragmatic philosophy, many parents with substantial wealth struggle to balance providing advantages that will propel their kids towards greatness and removing the incentives for hard work and productivity.

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Nepotism

Some have decided that they don't intend to leave an inheritance, so this isn't a big issue for them. For example, Yu Pengnian is a Chinese real-estate tycoon who is committed to giving away his billion dollar fortune entirely to charity. When asked how his children felt about receiving nothing, he said that they didn't oppose it. (Note that he didn't say, they celebrated the decision). Mr. Pengnian logic is rather simple though: “If my children are competent, they don’t need my money. If they’re not, leaving them a lot of money is only doing them harm.”

Along this vein, it appears that giving your children wealth is akin to saying that you lack confidence in their ability to find their own way. Inherent it the tone of his comment is a dislike of nepotism. Nepotism is favoritism granted to relatives or friends with no regard to merit.

Suppose your children have proven their merit?

Some would argue that families of some means don't have to follow Mr. Pengnian's model to have successful children. For those of us who purpose to leave an inheritance for our families, the challenge becomes finding the appropriate way to bestow our inheritance so that it enhances instead of destroys.

There are some interesting examples of how this is done. Possibly, the best example is Warren and Peter Buffet. Recently, Peter wrote a book entitled: Life is What You Make it: Finding Your Own Path to Fulfillment. It suggests that parents focus on giving their children values rather than spoiling them. Peter says it was the values he was brought up with that helped remain normal despite his family's wealth. He writes "values are the steady currency that earns us the all-important rewards." Moreover, he argues that it does your children a disservice to give them everything they want. Remember, his father is the ultra rich billionaire who famously lives in the same home that he purchased in 1958 years ago for $31500. Bufftet has also committed to giving away a 85% of his wealth to charity (the Gates Foundation). Thus, Peter argues from an extremely rare perspective.

Other prominent examples are Ivanka, Donald Jr., and Eric Trump who all finished school and went on to work for their dad's (Donald Trump's) enormous empire. Interestingly, it appears to me that Ivanka Trump finds it particularly important to prove herself. She graduated summa cum laude in economics from the University of Pennsylvania, initially interned someplace else, and even got a mortgage in one of her dad's buildings. Gary Vaynerchuk and Dylan Lauren (daughter of billionaire designer Ralph Lauren) are two additional examples of prominent offspring who have successfully moved beyond their parents brand to become successes in their own rights. I would probably even throw Nicki Hilton (Paris Hilton's younger sister) into the mix. She designs and famously said "I'm not a celebrity like my sister... I just design clothes..." when an interviewer was asking too many personal questions.

Not the Money That Ruins the Child

All of these examples show that money doesn't necessarily have to ruin the child. Now if you have a deep desire to donate most or all of your wealth to charity, such as Yu Pengnian, I doubt anyone who matters can really fault you. After all, you were the one who created the wealth in the first place. Note, only 2 out of 10 millionaires inherited a substantial portion of their wealth. However, there is no reason to disinherit kids in an attempt to prevent them from being spoiled rotten. In many cases, it was providing for your family that initially prompted you to pursue wealth in the first place. Thus, it would appear unfair to some if they were deprived the privilege to give to their children. However, according to Peter Buffet, the key to not raising trust-fund babies is making sure that your kids embrace the values you hold dear, such as strong work ethic, trust, tolerance, belief in education etc. As the seemingly well-adjusted son of the third richest man in the world, perhaps we should listen.

Aftermath

I know, many parents and even most of the kids would disagree with the viewpoint of this article. True, there are not many observers, who support it as well. In multiple articles the main idea is that leaving inheritance for kids is a straightforward parents’ duty. I’ll leave the question open. Everyone is finding its own answer, and there is no right or wrong solution.

Live long, healthy, and wealthy lives and let your children make their own contribution for themselves!

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