Planning for one’s death is typically not on the top of one’s “Can’t Wait to Do” list. However, such planning deserves attention and some effort. Most of us are working hard to provide for and support our children while we are alive. Most of us want our children to be provided for and supported after our death, too. Estate planning might be called one’s final act of parenting.
Estate planning includes determining who will inherit your estate (i.e. all your assets and liabilities), when they will inherit, how they will receive their inheritance, and how much and for what purposes. In this article, we are going to tackle this last point: How much should I leave my heirs and for what purposes?
For simplicity, we will assume the following: our children are our sole beneficiaries, assets will be left in trust to provide creditor protection and avoid an outright distribution before our children are ready, and that a trusted friend or family member will serve as trustee. Given this scenario, how do you decide how much to leave to your children?
Easy, Obvious, but Not Always the Best
One way to determine this, and probably the easiest, is to simply add all your assets and subtract your liabilities, giving you your net worth. Then divide your net worth by the number of children you have. For example:
So, in this example, if you (and your spouse if you have one) were to die, each child would receive $1M. This is a simple exercise, to be sure. But is this really the right number? Does it just so happen that your net worth, as of today, divided by the number of children you have is exactly the amount that would be the optimal for your children?
A More Thoughtful Approach
An alternative method is to put aside, for now, your net worth number. Instead, start with the question: What financial resources would help improve my children’s life course? (This question assumes you die prematurely and will not be present to support them.)
The answer to this question is highly personal and will vary, sometimes dramatically, from family to family. As an estate planner who has worked with many hundreds of families, I have seen common themes and areas where parents seek and make plans to support their children such as:
- Support for minor children. This would include living expenses (housing, food, clothes, etc.) until children reach age eighteen. Such a gift relieves any financial burden on your children’s guardians.
- Education. This is one of the most common things parents wish to provide, but there are several options. College only? Graduate school? What if a child does not go to college? Vocational school? What about private primary or secondary school? What about professional development to help a child change careers?
- Down payment for a house. This is a wonderful help for a child, allowing them a place of their own and to begin building equity. What type of house? How big? How much of a down payment?
- Medical emergency fund. What about support in the event of a chronic illness or significant injury? Many of us know someone who was essentially bankrupted due to serious health issues. Could we provide an emergency fund to help a child through such a life crisis?
- Business opportunity fund. Some of our children will start their own businesses. Do we want to support such a risky endeavor? Would it be better for a child to have to raise his or her own venture capital and have his or her own “skin in the game”?
- Supplemental income fund. I have never met a person who dreams of their son or daughter growing up to become a “trust fund kid”. This term describes an immature, entitled, underemployed adult living above the level of income he or she is able to earn. However, what about a child who decides to pursue a meaningful career that traditionally pays a low salary, such as some teaching positions, a career in the arts or in music, or working in a nonprofit organization? Creating a fund that would supplement a low-paying salary for a meaningful career can be a transformative gift to an idealistic and hard-working child.
- Retirement. Some parents decide to leave their children a meaningful retirement fund, a safety net for the later years when they may need it most and are no longer able to support themselves.
Different parents will have different reactions to the above support areas. Ultimately, parents must wrestle through what they feel is, or is not, important to provide for their children. You can download a How Much Is Enough Worksheet to come up with your own numbers.
Let’s make it practical
Let’s return to our original example of parents with a $2 million net worth. After going through a more thoughtful approach and thinking about key support areas, these parents come up with the following:
This set of parents is making certain decisions about what they feel is important and what will help their children succeed on their life course. First, they provide money for living expenses while the children are still minors. Next, they set aside money for education. This could be used for college, vocational school, or grad school. A child will be told they have $200,000 toward education, but they will have to decide how to use the funds. He or she may, for example, decide to go to a less expensive in-state college, allowing him or her to use some of these funds for graduate school.
Each child is told of the other funds, including a down payment for a house and funds to start a retirement account. While these are wonderful resources, each child will understand that he or she will be ultimately responsible for the bulk of his or her retirement and will need to plan accordingly.
As we see, these parents have successfully provided for their children with $1.4 million, giving parents a $600,000 surplus in their estate to be used for other purposes. If their net worth is $4 million, or $6 million, the surplus will be significantly greater. Parents will need to decide whether to increase what they leave for their children, or whether adding additional support funds would undermine their children taking responsibility for their own lives, potentially denying them the sense of personal accomplishment and healthy independence.
What if your net worth is less than your wish list for your children? Then, you simply prioritize how your assets should be used, such as focusing on obtaining a solid education to equip your children for meaningful employment. Or you may wish to purchase life insurance to get you to your target number.
I encourage every parent to ask themselves: what financial resources would help improve my children’s life course? May this help you identify what is most important to you as a parent, as well as facilitate a meaningful conversation with your spouse as you unify around what is most important to both of you. While we hope the fruit of such discussions will not be seen for many years to come, your children will be well served at some point by your thoughtful planning.
David Adams is an estate planning attorney at Pathway Law LLC (www.PathwayLaw.com), with offices in Belmont, West Roxbury and Norwood.
Copyright © 2017 by Pathway Law LLC
The author is grateful for Charles Collier and his book Wealth in Families for the concept of identifying gifts to heirs that will enhance their life course. See Collier, Charles. Wealth in Families. Cambridge: President and Fellows of Harvard College. 2012.