Building Generational Wealth Stage 2

When I wrote Building Generational Wealth, I outlined a system that I think would work well for most people.  I have since been asked “how can / should I give more money to my kids or grandkids than what you have outlined?”

Synopsis of Building Generational Wealth:

For Children:

• Giving matching funds each year to children to help them get to $64K total balance as quickly as possible.  $64K in your early twenties will become over $1 million by age 55 with 8% real growth rates.
• Paying for children’s further education with no debt.  This also includes being thrifty, going to community college, working while going to school, and applying for scholarships and financial aid.
• If possible providing matching funds for a first house down payment.

For Grandchildren:

• Gift $16,000 at birth, invested in a 100% stock index fund.  With an 8% growth rate this should grow into over a million by age 55.
• Then, because the children had received a substantial amount of help and don’t have to worry as much about saving for retirement, they are better able to help the grandkids (their kids) with education expenses and house down payments.  They will also be expected to give their grandkids $16K (or tax adjusted equivalent) at birth, allowing generational wealth to keep building. Each generation afterwards will then do the same.

I also state that if you can’t do all of these things, or any of them to this degree, doing something is better than nothing.  Maybe you can only gift $2,000 when your grandchild is born, great! that’s still an amazing head start that will grow to over a quarter million by age 55.

The guiding principles behind this were:

• To give kids and grandchildren a head start but not so much that they can do nothing.
• To give away assets before they appreciate.
• To keep giving to a close family group.

Building Generational Wealth Stage 2:

Stage 2 is when you have a substantial sum of money to give and you want to pass down more wealth than what is outlined above.  The first thing people tend to worry about is taxes. Currently the estate tax is only charged after $11 million per person is transferred, so that’s almost $22 million for a married couple.  Only about 1,800 people of the 2.6 million who die in our country per year fall into this category, so for the most part taxes are not the biggest issue, unless you are a 0.1 Percenter. There’s also a good possibility that the estate tax could be completely repealed in the not too distant future.  With that in mind, taxes are most likely not going to be a problem.

Assuming you have 2 kids and will have 4 grandkids, the total amount I talk about giving in Building Generational Wealth would be roughly:

• $64K in total matching funds for retirement savings
• $64K in money to grandkids at birth
• $50K for 2 kids to get through college (yes it is possible to do so this cheaply)
• $20K in house down payment assistance
• = Approx $200,000 total, or less than 2% of the individual tax threshold and less than 1% of the married tax threshold.

I think the majority of people reading this will fall into the group of people who can throughout their lives gift more than $200,000 but less than $11 million, that’s a pretty big range.  Also keep in mind that our tax laws change all the time and it is possible that estate taxes could either completely disappear or greatly increase between now and the time you pass.  This is an extra motivator to transfer money now while you know you can transfer large sums tax free.

For stage 2, the principals are still the same.  You want to pass down wealth as early in your life as possible, and as early in your children or grandchildren’s lives as possible. If it looks even remotely possible that later in life you will have wealth in excess of $11 million it makes sense to pass down assets as soon as possible.

You also need to be aware of the gift tax.  Under current tax law each individual can gift up to $15,000 per person per year without incurring tax.  Once you gift over $15,000 to 1 individual in 1 year you have to fill out a form with the IRS and any additional amount will be subtracted from your estate exemption of $11 million.  If you have 2 married children you can give each child and each spouse $15,000 per year, or $60,000 total, and then your spouse can also give each child and each spouse $15,000 per year, for a grand total of $120,000 per year.  The same limit of $15,000 each applies to grandchildren.

There is one interesting exemption to the gift tax and that is for gifts made to 529 college plans.  You can make a 1 time gift that is treated like it was made over 5 years.  This means each individual can gift $75,000, so a married couple can gift $150,000 to 1 person’s 529.

What Should The Mechanism Be?

I think that keeping it simple is the best route, for the most part expanding the numbers to the mechanism outlined in Building Generational Wealth will work just fine.

Continue matching funds to your kids retirement until they hit 128,000 total balance instead of $64,000 to get them through 1 more doubling period, or even higher if you choose. I’m a big fan of matching gifts because it provides an incentive for them to do some of the leg work as well.  There’s also nothing wrong with increasing the match from 1:1 to 2:1 or 3:1.

Gift your grandchildren the maximum tax free gift of $15,000 per year per person, so $30,000 per grandchild per year.  Instead of just a 1 time gift at birth, continue these contributions for as long as you deem necessary. With 4 grandchildren this could be $120,000 per year in wealth passed down.

Set Up A Trust:

I explained why I’m not a huge fan of trusts in Building Generational Wealth, however if you are planning to transfer potentially millions of dollars to your grandkids it makes sense to set up a trust.  Handing an 18 year old that kind of money without restrictions can be disastrous, roughly $64K is one thing, a few million dollars though, yikes. A trust allows you to put in stipulations on when and how the money can be received.  I would highly recommend NOT setting up a trust to be generational.  I would have the grandchildren receive all the money in their lifetimes and it would be up to them to pass on wealth to future generations.

Perhaps following what the royals and most old money families do is a good idea.  Allowing the young adults to only receive income from the portfolio, but not having the ability to take out principal, or make changes to the investments.  Unlike the royal families, I would then sunset this at a particular age, perhaps 50.  If the grandchild dies before 50, the trust would be immediately paid to his or her estate.

What about IRAs?

IRAs are a really good tool for passing down wealth, especially ROTH IRAs, however they have one glaring problem, you can’t pass them down until you die.  If you had kids young, and they had kids young then an IRA gift to them would not be as helpful as smaller sums of money earlier on.  What if each generation is roughly 20 years apart and you live to be 90?  Then your grandchildren will already be close to retirement by the time an IRA gets transferred to them. If you choose to pass down wealth at this stage in life, selecting great grandchildren (or great great grandchildren) as beneficiaries may make more sense, even though this does not keep the giving to close family members.

If you choose to go this route, chances are you have already passed down significant sums of wealth. Following the 2 kids per generation line, you will probably have 8 great grandchildren and 16 great great grandchildren.

I would set up the amounts to be equal per line, for instance if there are 8 great grandchildren each line would receive 12.5% of the IRA.  Most likely at this point in life no new great grandchildren are being born, so these lines are set, however each line might not be done having children of their own.  I would look at gifting each existing child 2.5% of the estate, which would allow for 4 children per line with the great grandchild also receiving 2.5%.  If they have fewer than four children then the share to the great grandchild increases.  Say if they have 2 children each great great grandchild would still receive 2.5% and the great grandchild would receive 7.5%.

The rationale for this is to keep each great grandchild family line even with each other (12.5% total), to give an equal amount to each existing great great grandchild (2.5% total), and to give the excess to the great grandchild so they will have the wealth available to gift to any kids who are born in the future.  After all it would be most unfortunate to be born 2 years after your great great grandfather died and because of this your older brother received a massive inheritance and you received nothing.  Because the excess was given to their parent rather than distributed as an increase to each existing great great grandchild at the time of the grantors death, the parent will be able to work on diverting this wealth to the new child overtime as tax law allows.  So with each great great grandchild receiving 2.5%, will it even be worth it? This may not sound like much, but what if the total of the retirement account is $5 million?  That’s $125,000 each.

The best part about gifting IRAs to young people is that their required distributions are extremely small, for a child the required distributions are under 2% of the total per year. Hopefully the parents would have their children take these distributions and reinvest them in their own brokerage accounts.

Update: June 2021: Since writing this article I have learned a lot more about building generational wealth.  Check out my new book about building generational wealth here:

How To Build Generational Wealth Book

What are your thoughts on building generational wealth?