When considering how your financial assets will be distributed upon your death, assessing your children’s level of financial responsibility is a critical component of making effective choices and creating a solution for a lasting legacy.
The truth is, developing good money management skills can take an entire lifetime.
There’s so much to learn about not only the intricacies of complex financial affairs, but also about personal strengths and weaknesses when it comes to investing, spending, and saving.
Financial maturity is something that must be earned. This is why 77% of people who win a lottery or come into some other kind of cash windfall end up broke within a few years. They just don’t know how to handle their newfound wealth.
For parents trying to figure out the best way to provide for their children, this question of financial responsibility is a big one. While a Will ostensibly ensures that your assets are distributed according to your wishes, a trust is a better option in many scenarios.
How does a trust work?
A trust allows you more control over how and when an inheritance is distributed to a child by putting a trustee, sometimes a trusted friend or relative, in charge of managing the assets. The trustee could also be the attorney who drafted the trust or a financial institution like a bank.
There are a variety of ways to structure a trust depending on your specific situation:
- Annuities: This is a trust that distributes the inheritance over time based on a payment schedule that you deem appropriate. Typically, payments are made in equal amounts each year.
- Incentive Trust: This term (sometimes called “Pay for Performance”) applies to any trust in which there are conditions the child must meet in order to “earn” distributions. Many parents tie distributions to the attainment of educational goals, but you can be as creative as you like. Some parents choose to connect distributions to more personal life goals or philanthropic service.
- Age-based Trust: A more traditional route to take is to set distributions based on the child reaching certain ages. (Just remember, age does not automatically equal wisdom!)
- Income-matching Trust: In this case, annual distributions are made in an amount matching the child’s earned income or a percentage of that income.
What about assets that are not monetary?
Alternatively, you can provide for your children via non-monetary assets. For instance, you might leave a home in a trust, ensuring that your child always has the comfort and stability of having a place to live. (To ensure your child can’t sell the house for cash, put the house in a trust that requires the money from any sale to be reinvested in another house.)
You can also earmark your child’s inheritance to be used for the purpose of paying off either student loans or a mortgage. (Just be sure to double check for any early payment penalties.)
There is no one-size-fits-all solution when it comes to leaving money to your kids. At the end of the day, you need to carefully consider their needs in the context of their personality and level of maturity. Sometimes, you might have to apply a little tough love, but they will thank you for it in the long run.