How To Prepare Your Adult Children For Their Inheritance

By: David M. Foster, CFP®, CAP®

How rich do you want your kids to be after you die? Being in a situation to seriously ponder that question means you’re among the wealthiest people to ever walk the face of the Earth. That might sound like hyperbole, but, for context, consider this chart:

Until roughly 200 years ago, nearly everyone on the planet lived in “extreme poverty.” Homo sapiens have been around for half a million years, give or take a few, and practically all of the progress we’ve made with regard to living standards has taken place within the lifetime of everyone reading this. Current pandemic aside, it makes you feel pretty great to be alive today, no?

The fact that you probably haven’t spent much time thinking of yourself as being part of humanity’s historical elite is a case study in and of itself. I believe there are two primary reasons for this:

1. We humans tend to focus on all the negative things happening in the world around us, even though all of the evidence suggests that the world today is as good as it’s ever been. This is probably because, from an evolutionary perspective, assuming the worst kept us alive. Reacting as if that rustling in the brush is a tiger who is ready to pounce upon and eat you is good for your survival, even if it is much more likely to be a bird or a squirrel.
2. We tend to compare ourselves to the people with whom we spend the most time interacting, and those people tend to look a lot like us, at least from a socioeconomic perspective. That is why, as the following chart depicts, only roughly a third of people who make more than $250,000 per year can correctly identify themselves as being part of the top income quintile, despite the fact that the top quintile begins at roughly half that amount.

The psychology behind all of this is fascinating (at least to me), but, for today, we’re going to set all that aside and focus on the question, “How should you prepare your adult children for their inheritance?”

We’re going to address 3 questions:

1. How much are they going to inherit?
2. How is this likely to affect them?
3. How should you communicate this to them? 

How much are they going to inherit?

This is probably the “easiest” of the three questions to answer. To be clear, this isn’t a question that can be answered with perfect precision, but the variables that are likely to affect it are mostly known and can be quantified, even if they can’t be predicted.

• How much do you have today?
• How much will you earn in the future?
• How much will you spend in the future?
• After accounting for taxes and inflation, at what rate do you expect your assets to grow/liabilities to shrink?
• When will you die?
• How much do you plan to leave to charity?
• How much will your estate owe in taxes?
• How many kids do you have?
• How much will your kids owe in inheritance taxes (sorry Nebraskans and Pennsylvanians)? 

Obviously, we can’t know, with absolute certainty, the answer to these questions with the exception of how many kids you have and the possible exception of your current net worth (If you own any assets where the value can’t be precisely known without actually selling it, such as ownership in a private, closely held business, we can’t really “know” that number either.). However, just because we can’t predict the future doesn’t mean we can’t make reasonable, educated guesses about how it might look. This is, essentially, the foundation of financial planning, and what my clients pay me for. Knowing whether this number is more likely to be $10 thousand or $10 million is crucial to addressing question number two.

How is this likely to affect them?

This section could be a 5,000 word blog post unto itself (and I’ll probably write one at some point), but, for today, we’ll focus on three broad potential outcomes.

1. It will change their life for the better.
2. It will change their life for the worse.
3. It won’t change their life.

For many people, receiving a $100,000 inheritance would radically improve their lives. You can probably imagine a young person using that to pay for their education or as a down payment for their first home. You can imagine a middle-aged person using that to start a business, bolster their emergency fund, or help pay for their children’s education. You can imagine someone in their 60’s using it to get over the hump to finally feel comfortable retiring.

For others, receiving a $100,000 inheritance would ruin them. You don’t have to look far to find examples of people who won the lottery and ended up dead or in debt. In these cases, these people won far more than $100,000, but, either way, a common theme emerges; if you have issues with substance abuse, gambling, and/or you lack experience having and managing money, then mo’ money is going to be equivalent to mo’ problems.

Of course, there are still others whose lives would be unaffected by inheriting $100,000. If your liquid net worth is already several million dollars, an additional $100,000 just won’t move the needle.

You can probably easily imagine how the number of zeros involved in an inheritance can move someone between categories. Someone whose life would be improved by $100,000 might be ruined by $1 million, or someone whose life wouldn’t be changed by $100,000 could have it radically improved by $1 million.

The point is that you know your kids better than anyone, and you likely have a good idea of how they would handle their inheritance if they received it today, without any preparation.

How should you communicate this to them?

Your answers to the first two questions will determine your approach here. I am, generally, an advocate of complete and total transparency when it comes to sharing the details about your money with your adult children; transparency in terms of how much you have, where it is located, how you acquired it, and what you intend to do with it when you’re gone. However, for most people to feel comfortable with this level of transparency, they need to feel confident that their heirs are in a good place to receive this information.

My definition of a “successful” inheritor is one who uses their inheritance to make the world a better place; better for themselves, their family, and/or their community. The people I’ve seen who have been able to do this generally share 3 characteristics:  

• 1.  They have their own financial house in order.
  • This doesn’t necessarily mean that they are wealthy on their own, it just means that they tend to live within their means. They don’t spend frivolously on credit cards. They understand that money is a means to an end and not an end unto itself, and that owning a bunch of “stuff” doesn’t equal happiness.    
• 2.  They lack a sense of entitlement.
  • They understand that they didn’t earn this money, and it is their job to be good stewards of it. How their benefactors communicated their money values will be the primary determinant of what it means to be a good steward of their inheritance. A lack of a sense of entitlement is often accompanied by a strong sense of gratitude. 
• 3.  The inheritance they received didn’t come as a surprise to them.
  • The larger the dollar amount in relation to the inheritor’s pre-inheritance net worth, the more important this category becomes. If categories 1 & 2 are satisfied, then an inheritor will have no problem absorbing a 10% increase to their pre-inheritance net worth. If that number is 1,000%, however, preparation is essential.      

What if you don’t think your kids can be trusted with information about their future inheritances? Is it because they are irredeemable, deadbeat, moochers (IDMs for short), or is it because you don’t believe they have a handle on categories 1 and/or 2? In my experience, there aren’t that many people who fall into the former camp. So, if it’s a question of getting your kids to be more responsible and/or less entitled, how can that be accomplished? Assuming your kids aren’t IDMs, I actually think the answer might be the very thing you’re trying to avoid: be transparent with them about their likely future inheritance!

In sharing this information with them, you’re likely to find out that either A) your kids might be better at managing their finances than you realized, or B) they are struggling to manage their finances and they need your help to figure out how to do it better!   

As far as the entitlement side of the equation goes, this is an opportunity for you to communicate what it will mean for your heirs to be good stewards of the money you plan to leave them. If you attempt to communicate this to them and their sense of entitlement remains, that may be an opportunity for you to rethink how you divvy up your assets. To be clear, this shouldn’t be a thing that you hold over their heads to force behavior change (if there was ever a recipe for creating resentment, this is it), but, again, the goal here is to make sure you are giving your children an inheritance that won’t screw them up, and if the way to accomplish that is to give them a little less, then so be it.

Many people will skip the step of trying to help their heirs become better qualified to receive an inheritance by creating restrictive trusts that will prevent them from directly handling or controlling the money. This, in theory, will protect them from themselves and/or any scammers, long lost relatives, etc., regardless of how well equipped they may be to handle it on their own. However, in my experience, people who end up being beneficiaries of substantial trusts over which they have limited control will often come to resent that money and, sometimes, even the person or people who left it for them.  

The bottom line is that by being transparent with your kids about what you have and what you intend to do with it, you’re likely to either gain knowledge about your kids that will help you to help them, or you’re likely to gain knowledge about your kids that will inform how you structure their inheritances.  

Putting It All Together

In summary, here is how you should go about preparing your adult children for their inheritance: 

1. Figure out how much they’re likely to inherit.
2. Spend time thinking about how inheriting that amount of money would likely affect them.
3. Talk to them early and often about steps 1 and 2 so that you can help prepare them to use their inheritance to make their world and the world around them a better place. 

Simple, right? I should have just written those three bullet points and called it a day. Would’ve saved me about 1,800 words and saved you about 7 minutes of reading😊

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The information provided here is for general information only and should not be considered an individualized recommendation or personalized investment advice. 

There can be no guarantee that any strategies promoted will be successful and no guarantee of positive results.