When You Definitely Need a Trust, Part 3: Protecting Your Heirs Against Their Own Youthful Foolishness

Most lottery winners have nothing to show for it 12 months after winning. The statistics for inheritance are depressingly similar. True, a larger inheritance (or jackpot) tends to take longer to spend. But for the most part, such windfalls do not solve “the money problem” permanently.

Leaving money to your kids and grandkids via a will (without a trust) does not give you much control over when they receive the money and how they spend it.

But if you’ve got kids (or especially grandkids) to whom you’d like to leave an inheritance, there are a few situations where it makes sense to have some guardrails.

Most 20-somethings do not handle large windfalls well.

First, a large windfall can short-circuit their drive to acquire skills and make themselves useful to the world. It is not generous to rob your kids and grandkids of the need to make something of themselves.

Second, most 20-somethings suffer from overconfidence bias. They don’t know what they don’t know, and so they think they know everything. Even if they’re frugal and good with their monthly bills, they still might not be well-equipped to invest large sums of money. Common mistakes are trading too frequently and taking too much risk. These behaviors often translate into mediocre returns that lag the market by a wide margin. Most amateur investors don’t track their own results and assume they are doing fine, particularly if they are in the middle of a bull market. Most don’t realize that investing is a skill that takes time to learn.

Third, bad relationships. 20-somethings are still learning how to be human and often find themselves in relationships that aren’t serving them or their partner well. Dumping a big pile of money into those situations does not usually things better. It might anaesthetize certain problems, allow couples to paper over deeper issues, but it is a poor substitute for the things that make a relationship work. Character, good communication, self-awareness, humility, generosity of spirit….

None of this is to say your kids and grandkids aren’t good people. In fact, I assume that your kids and grandkids are actually very good, well-intentioned people, trying their best. It’s just that in your 20s, you don’t know which way is up. You simply don’t have much life experience to draw on. You want to experiment, and try things. And you’re going to make a lot of mistakes.

So how do you give money to your kids and grandkids in a way that helps them have better lives, not worse?

1. You want to provide fuel for your kids and grandkids to live fully and grow into the best version of themselves. You can put stipulations in a trust that say, “this is only to be used for education (or travel, or a home purchase), at least until a particular age.” You can also put in certain performance-based clauses like, “$20,000 becomes available upon completion of a Bachelor’s degree,” or “ no distributions shall be made for 24 months if the beneficiary is using recreational drugs.” This money should enhance their lives, not fund an escape from it.

2. Everyone starts out unskilled at investing. It’s better to learn and make mistakes with a small sum, rather than screwing up your whole inheritance with a few dumb decisions. Shield your heirs’ assets from their learning curve by having those assets professionally managed, preferably with some broad instructions like, “the portfolio should be invested 80% in equities, split between broad-based index funds at the manager’s discretion.”

3. You can make funds available for couple’s counseling, or any other medical expenses for that matter. But at the same time you want to protect those assets from divorce, break-up, and other calamities. As I’ve mentioned elsewhere in this blog, you can put a pre-nup clause in place, saying no distributions shall be made if the beneficiary marries without a valid pre-nup in which the spouse disclaims all rights to these assets.

4. I know I’m outlining a lot of worst-case scenarios, in which receiving “free money” can make life worse. But ultimately, I think the dose makes the poison. Will $10,000 ruin your grandkid’s life or will it give them a buffer against disaster? Will $50,000 help them start a small business, or get an education they otherwise wouldn’t have? Does $15,000 allow them to see more of the world (and learn about themselves along the way)? Doling out money in small increments can maximize learning and growth, while avoiding the worst of the drawbacks. With time, your heirs may become wiser and better stewards of the money, until such time as all the guardrails eventually come off. And heck, if you feel good about helping them in this way, you can even start giving money to them while you’re still alive to see the difference it makes, while it still makes the biggest difference to them. It might even benefit them to have a guiding hand in using this money.

5. Help them learn while you are still around to teach them. Introduce them to your financial advisor, who is preferably someone who loves the process of teaching and educating their clients about investing, budgeting, and taxes. Or, talk through their plans for the money. Are they going to travel? Ask them how they are thinking through all the expenses that might arise. Introduce them to the concept of conservative planning, leaving a safety buffer so that they aren’t stranded in Cambodia with $0 to their name. Warn them about the dangers of consumer debt, like credit cards and auto loans. Help them understand the values and drawbacks of home ownership. There’s so much you can share from your own life experiences that could really help them. And who knows? This time might really deepen your relationship with one another.

6. Establish expectations while you are still alive. It is helpful to be forthright about what they can expect to receive from you, even if you don’t discuss specific dollar figures. Communicate the restrictions on these funds, and what they are intended for. Stress that it is your intention to help them live a fuller life, and become more of themselves, not to spare them the difficulties of building a career and financial future. These funds may best be seen as an investment in your kid or grandkid’s personal and professional growth, rather than merely their portfolio. If they are going to have good lives, they must learn to take on adult responsibilities.

When leaving money to younger adults, it often helps to provide some guardrails to protect their inheritance from their own learning curve. But more importantly, I think a lot of older adults underestimate how impactful a few conversations about money can be for their younger relatives. Remember, personal finance really isn’t taught in schools; most people reach adulthood not knowing anything about money. Don’t leave them hanging, share some of your knowledge and experience.