Aug. 31, 2018
Many people agonize over when to let their kids take control of their inheritance. Some parents choose an age, some choose a milestone. But, there is no age or milestone that guarantees a child is mature enough to use their inheritance as we hope they will. When my daughter was born, I tried something different that I think has avoided the usual pitfalls and provided her with a safety net that amplifies her efforts to find her place in the world.
Simple as Riding A Bike
The key insight is that I want our safety net to act like a bicycle for my daughter’s life. Just as a bicycle enables anyone to travel farther and faster than someone who is on foot, our safety net enables my daughter to go farther and faster in life than she otherwise could have.
However, a bicycle won’t take you anywhere unless you pedal. I don’t want her to have our money if she is not “pedaling”. If for some reason, our daughter doesn’t want to develop her talents, I would rather have the money go to another of our children (or grandchildren) who does.
So far, I have used our safety net to fully fund my daughter’s IRA every year she is eligible, pay for her health insurance and even cover her income taxes.
The safety net I’ve created reflects the challenges I’ve faced and the mistakes I’ve made in my own life that I hope to spare my daughter.
When I was a kid, the maximum contribution you could make to an IRA was only $2,000. But since I only made $2,000 working all summer, it was a hard sell to get me to put all of it into an IRA. But now I wish I had. Those early contributions that I never made would have made a big difference for me later in life.
When I was in high school, I saw even less need for health insurance than for an IRA. After all, health insurance was expensive and I had never been sick. Now that I’m older, I’ve seen many people get stuck in jobs they don’t like because it’s the only way they can afford health insurance. My daughter is going to spend a good portion of her life at work. I’d like her to be able to choose a career she loves without regard to their health plan.
As for paying her income taxes, I remember getting my first paycheck as a teenager and being surprised at how little was left after taxes were taken out. It’s easy for kids to question the wisdom of having a job when taxes don’t leave them much to show for their effort. I hope that having the safety net pay her taxes tips the scales back in favor of working.
These are a lot more things I want to use our safety net to fund for our daughter as she gets older, as long as she is pedaling.
The Usual Pitfalls
Setting an age or milestone at which point a child basically becomes wealthy has some pitfalls that I think the safety net approach avoids.
I have seen children who had to wait until they were in their 30s and nevertheless managed to use the money to finance self-destructive behavior. We don’t like to think about it, but there are lots of things our children could do with our money that we would not want to encourage, much less enable.
I have watched people fritter their lives away because nothing they can ever do will affect the trajectory of their lives more than reaching the age or milestone set by their parents. Why work hard when at some point they will be rich no matter what. They never learn to pedal for themselves. It becomes hard for them to see themselves as anything other than their parents’ child.
A second pitfall is that this kind of arrangement draws a target on your child that attracts people who want to take advantage of them. Sycophants and hangers-on make it difficult for young adults to tell who their true friends are. Even worse, I’ve seen young adults get recruited into cults whose main interest is to solicit large donations.
A third pitfall is that if you wait until they are adults, you miss the best opportunities to shape their values when they are young.
I think the best thing I can do for my daughter is to support her efforts to grow up to be a net plus to the world. I can’t do that by setting things up so that her own efforts can never outweigh the impact of reaching an age or milestone.
Managing A Safety Net For Your Family
When it comes to managing a safety net for your family, some of the basic investment principles that have been developed for pension funds don’t apply.
A pension fund has to make payments to plan participants from the day they retire for the rest of their lives. The payment does not change regardless of need be it an emergency or otherwise. This is what enables a pension fund to invest for the very long term — 30 or more years. There have not been that many 30 year periods over which the market has declined so it can make sense for pension funds to invest in broad market index funds and not try to do better.
In contrast, I want the safety net for my family to take effect while my child is young so I have to invest with a much shorter time horizon. There have been many three to five year periods over which the market has declined. The shorter the time frame, the less confident you can be that a market index fund will make you money.
If you expect the market to be below average, flat or down over the next three years (which can happen when interest rates are rising), it makes sense to invest in stocks that can overcome the drag of the market rather than a market index fund.
If we start planning when our children are young, we can build a better safety net for them than the government ever dreamed of. That is something I am proud to set up and manage for my family.