4 Tips to Help Make Multi-Generation Wealth WorkSubmitted by AssetGrade, LLC. on August 23rd, 2017
Submitted by Patrick Cote on August 23, 2017
How to avoid “shirtsleeves to shirtsleeves in three generations”
Congratulations! You are on track to accumulate enough wealth to consider yourself wealthy (or maybe you are already there)! Now what? If you have kids (or nieces and nephews), one of your biggest concerns is likely to be to ensure that they, as well as future generations of your family, are able to benefit from the wealth in a positive manner. Even if you don’t think the amount you will leave to future generations is going to be that substantial, many of the tips below will still help.
At AssetGrade, we have had a number of clients ask for help with multiple generations of their family. In particular, we are focusing on ensuring that the priorities and goals of each generation are aligned where possible. We have seen our clients be most successful when they have kept the multi-generation goals specific and manageable.
For most folks who are the original creators of wealth for their family, whether they are HENRYs (High Earners, Not Rich Yet) or already wealthy, they want to see their children and future generations benefit from the family wealth by getting a great education and helping them with a head-start to lead fulfilling, productive lives. They want to avoid scenarios in which the wealth becomes a negative influence on the family. A good financial plan can help define these specific goals for your family.
The phrase “shirtsleeves to shirtsleeves in three generations” refers to the following common story:
- The first generation grows up without money when they initially create the wealth
- The second generation experienced life without wealth when they grew up, so they are better able to appreciate the wealth when it comes along
- The third generation has faced fewer hardships and has only known wealth, so they become more focused on spending it than earning more wealth, until the wealth eventually disappears
This “shirtsleeves to shirtsleeves in three generations” effect is remarkably common and has equivalents in Mandarin and Italian, which gives a sense of how this effect cuts across cultures.
The good news is that not all families are doomed to fall into this trap. I recently had the chance to chat with Harry, who is now in the 5th generation of wealth with his family – their wealth began in the 19th century. To help maintain confidentiality, his name has been changed and key family details are not included, since so few families have managed to preserve wealth beyond three generations.
There are four lessons that emerge that many families, even those who are not yet wealthy, can immediately adopt:
- Share the origin story of the “family founder” to plant the seeds for a culture of gratefulness/frugality
- Set key expectations about working and spending
- Encourage the next generation to take leadership roles and strive for self-actualization
- Be thoughtful about the investment/legal structure
The big take-away is that money is not the primary focus – instead wealth becomes the end result of the family priorities. By continuing to share the same values and work towards common goals, Harry’s family is able to maintain this success over multiple generations.
Creating the success that Harry’s family did takes years and a good deal of effort and coordination. Fortunately, there are some relatively quick steps that we can all take that don’t have to involve a lot of time, effort and uncomfortable conversations with other family members:
1. Start with a great origination story when possible, as this will set the tone for the family down the road
There is usually an interesting story involved with the original creator of wealth in the family. In Harry’s family, the family member who created the wealth originally came from another country and worked hard to build his business. Along the way, he continued to focus on doing good as well as creating wealth. He stayed a “man of the people” along the way even as his wealth increased. Multiple stories abound within Harry’s family about how he was able to do so. Reputation was a key factor in older generations, which helped propel this effect. To this day, Harry’s family continues to feel good about the family fortune, all starting from the positive initial creation of wealth. (To maintain confidentiality, the origination stories from Harry’s family cannot be shared, which is unfortunate as they are indeed inspirational and entertaining!)
If you are the one creating wealth for your family and you have a good origination story, be sure to share it with your family. With an origination story, the wealth becomes an outcome of good values that formed the family. The family values are important whether or not the family is wealthy, which helps the members of the family have a positive identity independent of the wealth. To really have an impact, those values should be demonstrated, captured in stories, and passed on to the next generation. As geography, time, and diversity separate the family from its origination story, each generation can rediscover itself and choose to stick together. This does require effort on the part of each generation to continue to maintain ties through activities like family reunions, whether or not the family is linked through a common family business.
2. Set key expectations with everyone about working and spending
This is common sense, yet one of the harder lessons to execute in practice. Once the wealth is in place, the pressure to get a great education and work hard can easily disappear.
It can make a big difference if the family emphasizes education and encourages everyone to live within their means. For Harry’s family, they are very conscious of sustainable withdrawal rates. This helps them avoid one of the biggest traps, especially for the third generation and beyond, of spending more than they earn (which can be a challenge for families of all wealth and income levels!). Within Harry’s family, they did let their spending grow over time in a controlled manner. However, they maintained an ongoing sense of frugality even as the family wealth grew.
Many families will help the younger generation with education and potentially provide some support after graduation. Irrespective of the amount of wealth, the key is to agree on and have the younger generation acknowledge what they are expected to do on their own.
3. Encourage leadership in the next generation
As the wealth and the family continue to grow, it requires significant effort from everyone in the family to ensure that future generations buy in to the value of family over wealth. Bringing up each generation in a positive culture makes a big difference as people see value from their participation in the family.
In Harry’s family, they continue to invest in their own social, network, human, and other non-financial capital. Each generation starts grooming their successors at a young age by giving them leadership opportunities where possible. This happens through a variety of boards and committees that serve the family’s collaborative interests. When the time comes, they entrust the rising generation with more and more responsibility to help them become comfortable with taking charge of the family wealth management, family office, family businesses, and family foundations. Harry’s family holds regular reunions, business meetings, and educational outings that mix fun with the important work of the family.
Most families will not have the opportunities that Harry’s family has for boards and foundations. However, the younger generations can still be encouraged to take part in family reunions, be active in their communities and continue to strive for self-actualization, which will likely help them become happier and more fulfilled (and perhaps steer them away from simply spending any inheritance they receive).
4. Be thoughtful and coordinated for the legal/investment structure
The estate tax laws continue to evolve at both the federal and state levels, so it is critical to be thoughtful about the type of legal structures used. The current federal estate taxes kick in at $5.49M per individual and $10.98M for a married couple. However, estate taxes by state can kick in at much lower levels, such as $1M per person in MA, OR and DC. When we consider that real estate is included in determining the size of the estate, it is easy to see that many families could be impacted by estate taxes at the state level.
Most 18 or 21 year olds are not yet ready to handle a large amount of money, so imagine the problems that can occur if it all went to them in one shot. The key is not to give lump-sum amounts to beneficiaries, particularly at a young age. A good estate plan will help avoid this type of situation through the use of trusts or other legal structures. Having some of the wealth tied up in illiquid investments, such as real estate or family businesses, can also help, as long as the illiquid investments do not need to be sold off to cover estate taxes. Harry’s family focuses on maximizing the after-tax long-term returns on their investments by using low-cost investment products, watching their fees closely and staying broadly diversified.
For families that do not have the level of wealth at which they are worried about estate taxes, there are still some easy areas to help address basic financial goals. For example, since paying for college is a challenge for many folks, including many HENRYs, coordinating contributions to 529 accounts between parents and grandparents is relatively simple and does not require extensive legal preparation or uncomfortable conversations about everyone’s finances. It is an easy way for families to get aligned and help achieve one of their key financial goals of supporting the education of the younger generation.
Harry’s origination stories led to a culture of stewardship for future generations. Each generation appreciates the generosity of the prior generations and identifies as a servant of the next generations. The norms and expectations serve to temper consumption, set the expectation of wealth preservation, and foster long-term planning necessary to keep a family together.
A family founder should pass on values, not just wealth. These values are captured in actions that speak to the generations that live long after the founder. Each generation will need to choose for themselves to keep the family going. With more than money holding them together, they might choose to stay closer together.