Inheritance and Intergenerational wealth transfer

Do you plan to leave your kids an inheritance to pass along intergenerational wealth? Read below to learn if this is a good idea.

Intergenerational wealth transfer is the passage of wealth from one family generation to the next. This is a touchy subject in my family. As I plan our financial future, we often debate about this.

How should we go about generating enough wealth to have enough to pass on? Is it even moral or advisable to pass on wealth to the next generation?

The Darwinian Dr-ess

The Darwinian Dr-ess has already received much of her inheritance in advance, in the form of fully paid education and significant help in purchasing our home.  While not a typical inheritance, this certainly can be called a transfer of intergenerational wealth. This money has given us a significant jumpstart to our net worth.

My wife doesn’t expect to get much else after her parents pass, and this is by design. Most people think of inheritance as something you get when an old parent or relative kicks the bucket.

But the Dr-ess’ parents chose to give advantages to their children while they were still alive and well. This is technically called inter vivos wealth transfer, that is, from one living person to another.

These advantages translated into unique educational  opportunities and a higher quality of life. Also, her parents got the chance to enjoy watching their kids benefit from their generosity and choices in a way that dead grandparents sadly cannot.  

The Darwinian Doctor (that’s me!)

In my own family, my parents were not so fortunate to have much money to contribute to my collegiate or postgraduate education.  They didn’t contribute to our house downpayment, and there won’t be much to pass on when they’re gone.

None of this prevented me from achieving my goals, but I certainly do have a lot more educational debt than my wife.  

In lieu of money, my parents transferred intangible things, like drive, morals, and the value of education.  (To be clear, the Dr-ess got these things as well.)

While not an inheritance in the typical sense of the word, these intangible assets are just as valuable, and have served me well to bring me to my current position.  I’ll be forever grateful for these gifts.

What about our kids?

Random cute kids

When the Dr-ess and I discuss leaving a legacy behind for our own kids, we disagree.  Having experienced real financial scarcity in my childhood, I never want my children, or their future children, to experience the same.  It was unpleasant and frankly scarring in some ways. In the dusty corners of my mind, I fear a return to those days when my family didn’t even have enough money to buy a meatball sub for dinner.  I don’t know how large of a net worth it’ll take for this fear to go away, but I’m not there yet.

I intend to buy financial security for my descendents by building a large portfolio of assets that will continue to grow even after I am dead and buried.  Somehow, I’ll also need to safeguard against the money being wasted by spendthrift grandkids or great-grandkids. What’s the purpose of building intergenerational wealth if some unmotivated scion in 100 years spends it all at the horse races? But that’s a topic for another day.

The Dr-ess feels that it would be smarter to do what her parents did for her:  give advantages early in life, help avoid crippling educational debt, and then rely on our kids to do the rest.  Her worry is that by providing too well for our kids, it will sap them of the motivation needed to be successful on their own.  

Trust fund babies

She often brings up the cautionary example of “trust fund babies.”  Picture the obnoxious, entitled 16 year old kid driving around in the convertible BMW, treating everyone like dirt.  Or the 28 year old jobless “entrepreneur,” who actually just eats cereal and plays Xbox all day, courtesy of their trust fund checks.

Those are vivid images of the type of kids we do not want our boys to turn into.

Should we leave an inheritance to transfer intergenerational wealth?

I think most people understand the desire to leave behind assets for future generations.  In the same way a nice down coat insulates our kids against the frigid winter wind, building a financial legacy can insulate our descendents against financial ruin.

But is it a good practice in general?  What does it do to someone to get an inheritance and perpetuate intergenerational wealth?

I found a US Federal Reserve research paper which examines this very question.

Does their research support this quote by Andrew Carnegie, which argues that wealth leads to less motivated and productive workers?

“the parent who leaves his son enormous wealth generally deadens the talents and energies of the son, and tempts him to lead a less useful and less worthy life than he otherwise would…”

The Carnegie Conjecture

There is some evidence for Carnegie’s opinion.  Holtz-Eakin, Joulfaian, and Rosen in 1993 decided to study this very topic in the early 1980s.

They found that those who inherited over $465,000 were over four times as likely to stop working than those who inherited below $77,000 (dollars inflation adjusted to 2019).  

To me, this is just common sense.  For most people, a half million dollar inheritance will certainly make work optional, at least for a time.  This is the epitome of a transfer of intergenerational wealth.

I found their next conclusion much more interesting:  being “born to wealth” allows people to take risks in a way that most cannot.  

Risky business

“Risk” is usually portrayed as a negative concept, something to be minimized.  If we are talking about driving, taking a flight, or performing surgery, I think we’d all agree that less risk is better.

But if we are talking about making money, more risk can mean more reward.  

The most commonly recommended method to achieve financial independence is stock market investing, which has inherent short term risk and volatility.  But historically, stock market investing has yielded a robust 7-10%. In comparison, less risky bond funds would be expected to yield 4% or less (pre-tax).

If you are willing to tolerate the risk of volatility, history shows that as a whole, the stock market inexorably marches upwards.  

Source: Macrotrends

This all shows that calculated risks in the stock market can yield better rewards than the safest investing options.  

The same goes for business opportunities. And you know what makes business risk easier to tolerate? The “insurance” of familial money.

The value of insurance

People take out insurance policies to insure against the risks of everyday life, such as car crashes, house fires, and even death.  These policies aren’t cheap. But most would agree that the risk of disaster without the policies justifies the cost.  

Just a couple of months ago, I consolidated and upgraded my insurance policies under USAA.  We now have our auto and homeowners with them, and I even picked up an earthquake policy! Although it increased my overall annual insurance costs to over $7000 a year, it’s given me considerable peace of mind.  

Unfortunately, the very people who need these insurance policies the most often cannot afford them.  Look at uninsured drivers, who with one crash, may face financial ruin.

Familial insurance

The concept of “familial insurance” presents a type of insurance that can’t be bought from Allstate or USAA.  If you have familial insurance, you have the assurance that if things go financially wrong, you can depend on your family to bail you out.  

This concept is different than a traditional inheritance that directly passes along intergenerational wealth.

For example, imagine the young entrepreneur deciding whether or not to spend $25,000 of savings to try to start a business selling dog walking services or to start a pop up restaurant. That entrepreneur would probably be more willing to take the risk and spend the money if she knows that if it all went kaput, she could lean on her family’s resources until she’s back on her feet.

What did the evidence show?

The Federal Reserve paper found evidence for this line of reasoning. They found that 37% of those born to wealth are willing to take on more risk to get more returns, as opposed to only 21% of the rest of the population. (They defined “born to wealth” as inheriting over $1 million in 2016 dollars.)

More importantly, this freedom to take more risk led to a 400% better chance of starting a successful business!

In business, more risk can equal more reward

Conclusion

As I’ve previously mentioned, I want to have it all.  I want to protect my family from the ravages of financial scarcity and give them the security of their own “familial insurance” when they’re getting their careers underway.

With discipline, planning, and prudent investing, the Dr-ess and I should have enough assets to give our kids advantages in their early life, as well as leave them an inheritance as well.  

It doesn’t feel very motivating to just build up a stockpile of money to just blow it all during retirement. Building up a self-replicating portfolio of investments to allow for intergenerational wealth transfer, however, is something that really lights my fire.

While doing this will not be easy, I think the harder task is going to be achieving all of this in a way that doesn’t lead to entitled, spoiled brats.  

Any suggestions?

— TDD

What do you think?  Are you going to leave behind an inheritance and pass along intergenerational wealth?  Did your own “familial insurance” let you take more risks in your life?  Share, comment, and subscribe!

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Dr PayItBack
3 years ago

I think the feeling of security is huge psychologically. I was in the cohort that graduated college with the falling knife of the recession. My parents lost their jobs almost simultaneously; was a very scary time. To me, getting into medical school and finding a highly-compensated specialty that I was good at felt like grabbing the end of the ladder as it was about to be pulled up and out of reach. Things are good now (and I’ll be the first to admit that many, many folks had it worse than me), but I never want my kids to know that level of uncertainty.

Stephen
Stephen
3 years ago

My primary goal is to more give relief to the things that cause financial stress in the present day. Contributing to their IRA’s, helping with their first cars and homes, providing a nice place for a vacation. I get the enjoyment, and I’d like to think I help them to have less to worry about.
I would hope to leave an inheritance, but it may well get passed down a generation as my children may not need it if they are already retired at that time.
Additionally, for me, I have many blessings and privileges, and would want to give generously to needs present in my community and world.

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[…] If we play our cards right and invest well, we’ll have money left over when we buy the proverbial farm. The Darwinian Doctor contemplates what the future might hold for his heirs. Inheritance and Intergenerational Wealth Transfer. […]

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