What to Do with an Estate with Foreign Assets (Even that “Little” Bank Account in Europe)
Deferral is a traditional strategy: pay to raise and educate your child, and then give them not very much (if anything) until they inherit as your survivor.
Ad hoc gifts are transfers for a particular purpose, such as paying off credit cards, covering club assessments, grandchildren's tuition, buying a vacation home, or capitalizing a business.
Income streams are arrangements (often using trusts, or partial ownership of businesses or rental real estate) that provide ongoing income to the child.
As an aside, please bear in mind that by "Upper Class", I'm referring to families in which children could inherit more (sometimes, much more) than $5 million each. Especially if parents can transfer that much wealth to each of two or more children, the parents themselves are likely in a substantially secure financial position, even after making lifetime transfers to their children.
For discussion purposes, this creates freedom to focus on how wealth transfers affect children, rather than parents.
Each type of inheritance strategy presents pros and cons.
Deferral can be tempting in certain conditions.
Parents might have lingering concerns about their own financial security (particularly if their lifestyle spending is high in relation to their asset base).
Parents might view their children as irresponsible, and be concerned about gifts reducing a child's work ethic.
Parents might be undecided about ultimate allocation of their wealth between their descendants and philanthropy.
Parents might simply be strong personalities who prioritize control over other objectives.
Deferral's downsides are expressed over time, in ways that can be hard to observe in the near term.
Adult children finally inherit when they are in their 60s and their parents are in their late 80s or early 90s. The children receive large wealth when it's too late for that wealth to allow them to pursue careers of choice rather than necessity, and after grandchildren are educated.
Adult children may experience "sudden wealth syndrome" and make (perhaps) large unwise purchases, in an effort to enjoy the wealth they've waited for while there's still time.
Adult children who didn't want to wait for a large inheritance may have taken very speculative business risks in early and mid-career; if these risks didn't pan out, their debt burdens can present problems.
Ad hoc gifts may make sense on a case-by-case basis.
A child may need a down payment on a first home.
A grandchild may need to go to college or graduate school.
A parent may want to congratulate a child on reaching a milestone, or on a particular achievement.
On the other hand, ad hoc gifts can create very perverse incentives.
A child learns that bailouts from credit card debt are possible.
A child learns that parents will backstop "social image" spending on clubs.
To receive parental funding, a child has to pursue entrepreneurship, even if their heart isn't really in it.
Ad hoc gifts also present fairness issues in families with multiple children, because ad hoc opportunities vary in size and timing. How will gifts be equalized in a way that is fair – and beyond that, is seen as fair by all siblings?
An unspoken competition can develop among siblings to see who can get the most from mom and dad. As you might expect, that turns siblings into "frenemies" at best and outright enemies at worst.
Income streams created for a child (for instance, by a unitrust, or by gifts of partial interests in a business, investment partnership, or rental real estate) can be an attractive wealth transfer approach for several reasons.
Once the income stream is arranged, the cash flows to the child are relatively predictable.
The child can use income flows to service debt. This allows the child to borrow to fund major purchases or investments, without needing to turn to parents for case-by-case lump-sum funding.
In certain instances, income streams can present downsides.
A child who is co-owner in a business might object to the parent's business decisions or cash distribution policy, and family discord or even litigation might ensue.
The value of unitrust assets or the business might soar unexpectedly, and the child might become "too rich, too soon."
Children with the cash they need might become ungrateful and/or inattentive to parents.
For Upper Class families, I am partial to the income streams inheritance strategy, compared to deferral and ad hoc transfers.
A child can make much better financial decisions knowing what his or her income will be, and that relative predictability is what the income streams strategy provides.
Without having to ask parents for ad hoc transfers for particular purposes, I think adult children maintain more independence and dignity.
When wealth transfer isn't completely deferred until children survive parents, a family's financial capital can be used more fully to develop the human capital of grandchildren and more remote descendants.
In turn, higher human capital makes it much easier for families to protect and grow multigenerational financial capital.
In my experience, potential problems with the income streams inheritance strategy can best be avoided by not using it in the wrong situations.
Parents should not transfer future cash flows to children unless they are objectively and subjectively extremely financially secure themselves.
Parents and children who will be co-owners in a business or real estate delivering income streams to children should have positive relationships of trust and confidence.
That's because closely held business ownership by co-owners who don't like and trust each other can be fraught with problems – whether or not the co-owners are related.
When parents hold enough wealth that inheritance will dramatically change their children's lives, they will obtain better outcomes through careful review and implementation of the particular mix of deferral, ad hoc transfers, and income streams that best fits their family.