You’re an optimist. The stats say 70% of inherited wealth is lost by the second generation, 90% by the third (the 3rd generation rule). The vast majority of rich kids are not taught about handling money responsibly (for the usual reasons) and attempts to shield the money from their shenanigans while still making it available after they inherit don’t work.
But it wouldn’t have to be indefinite. Assuming you live a typical life, your grandchildren are already going to be approaching their 21st birthdays by the time you die and the trust kicks in. Eighty years after your death should be enough time to cover their children and grandchildren.
If I were trying to do this, my personal feeling is that today, your best bet is probably a passively-managed equity portfolio (i.e., index ETFs) with a few Treasury bonds and maybe some REITs. I still wouldn’t expect the plan to succeed for lots of reasons.
Direct investment in income-producing real estate is a good durable investment but it can be mismanaged easily and it can fail. It can also lag behind alternative investments for generations and so not accomplish its objectives. Has real estate in West Virginia earned a lot for the last 50 years? Is coastal real estate a good bet based on its historical appreciation or a bad one due to global warming and possible changes in flood insurance policies?
Although I laid out the plan I would try to use today, if you had asked me in 1950, I would probably have said a portfolio of 1/3 blue chip stocks managed by a good money manager, 1/3 bonds, and 1/3 real estate. The cost of that management would have outweighed any benefit it brought, and so I would have been setting up the trust for disappointing returns. It also would have generated needless taxes. If you had asked me in 1980, I would have said to use index mutual funds. Over time though, this is less tax efficient and has higher management fees than the ETFs that are supplanting mutual funds. I don’t know what will be better than ETFs in the future. With fewer companies going public today than 20 years ago and companies going public later than they used to, the future might mean that venture capital has the best potential returns, along with tremendous risk The problem is that I can’t see the future, so I would have to give the trustees discretion to manage the trust appropriately with all the risk that they will misjudge. If I do that, it’s really not fundamentally different than just giving my theoretical kids the money and teaching them the principals of sound investment management so they can make good decisions. Not all of them will.
$10 million isn’t intergenerational wealth. It’s a nice leg up for your kids but little more. There are lots of problems with expecting $10 million to last essentially forever. The problem is that the portfolio has to grow after taking into account: (1) inflation, (2) taxes, (3) management fees, (4) distributions to make it actually useful to the kids, and (5) the likely increasing number of beneficiaries over time.
Let’s take these in order.
(1) Inflation The long run rate of inflation has been about 3.25% for the last hundred years. Can you count on that rate forever? Probably not. What’s a conservative guess for the next three hundred years? I have no idea. It might be something like 3-4% if the American experiment succeeds. It might be 5,000% per year if it fails. What should you target as a rate of capital appreciation to exceed this rate of return? Let’s say 4% so we can move the discussion along, but this may be way too little.
(2) What are the taxes going to be like? Assume that your trust does grow to be huge. It’s always going to be in the top tax bracket. Today, anything over $12,500 in income is taxed at the highest rate of 37% federally, plus whatever state taxes you owe. Given today’s deficits, the idea that taxes might have to go up in the future seems likely. This is only on taxable income, which for a trust would include things like interest, dividends, realized capital gains, and net rental income. If you invested your whole $10 million in an S&P 500 index fund, you would have income of about $225,000, which would incur trust income taxes of something like $90,000. You would also owe some taxes for capital gains each year. Today, you can let the unrealized gains carry over each year without paying taxes on it but will that remain true for 300 years? Let’s just say that in rough numbers, you need to pay income taxes equal to 1% of principal every year. That’s a drag on your returns.
(3) Someone needs to be the trustee of the trust you are going to establish. If the trust gets big enough, the trustee rate will drop as a percentage of assets but let’s just say that the trustee will charge 1% of trust assets each year to manage it.
(4) How much do you want the kids to actually derive from the portfolio? Right now, the first 6% of the portfolio’s return is doing nothing but helping to keep the trust above water in real terms. How much can you safely pay your descendants without killing the portfolio? You suggest maybe 2% is a good number. Okay, all the kids can share $200,000 per year. That’s not too bad. It means that your target rate of return is approximately 8% per year (4% inflation + 1% income taxes + 1% management fee + 2% distributions to the descendants). Is this realistic? It is less than the long run return on equities for the last 70 or so years (~10%) but nominal bond returns have been only about 4.5%. If you are targeting a return of 8%, based on the experience of the last 70 years or so, a portfolio of 35% bonds and 65% equities would have accomplished that. However, do you have any guarantee that you will make these returns going forward? Right now, equity valuations are very high and some people are suggesting that with fewer early stage companies going public, all the best returns will accrue in the future to private equity investors in early stage companies. The equity market future might be very disappointing compared to the past.
There is also a problem in that the returns are spiky. If you have a few years of negative returns when you are still making 2% distributions to the kids, the portfolio will shrink very rapidly and have a tough time recovering. Monte Carlo simulation can give you some estimate of the risk over any given period but generally people are looking for something like a 95% chance of success over a 40-year retirement. With the same level of risk, the same portfolio over 300 years would have perhaps a 0.000001% chance of success.
(5) Finally, all that is so the kids can share a real return of $200,000 per year. Your number of descendants is still growing exponentially when all your portfolio is doing is staying put. If you have two kids, and each of them has two kids in roughly 25 years, ad infinitum, your number of descendants is growing exponentially at a rate of roughly 2.8% per year. In just 100 years, you would expect to have 32 great-great-great-grandkids to share the $200,000 in today’s dollars. So, they would each get about $6,000 per year (disregarding any share their still living parents/grandparents/etc. would share). After 300 years and with 8,192 descendants in the last generation, they each get about $24 in real terms. That’s hardly going to allow them to live the life of idle leisure. Feudal lords eliminated this problem with primogeniture. You could similarly allocate all the trust benefits to just one kid from each generation but that seems unfair and I don’t think that was your plan.
You can also overcome this problem by trying to grow the portfolio in real terms at a rate to account for the exponential growth in your descendants. If so, you are now trying to target a rate of growth of over 10.8% per year. (4% inflation + 1% income taxes + 1% management fee + 2.8% for growth in descendants + 2% distributions to the descendants). Even investing in equities over the last 70 years wouldn’t have accomplished this and we only know with the benefit of hindsight how to pick an investment as good as equities. Your chances of picking any investment strategy today that will do better than this over a 300 year time horizon is approximately zero.
I agree. Real estate can work wonders or it can crash into the ground in just a few short years. It is no panacea to the problem of sustaining intergenerational wealth.
Most states have done away with the rule against perpetuities. There are real problems trying to create multi-generational wealth, but this isn’t it anymore.
I believe this is exactly right, though I don’t have any kids of my own, so what do I know?
You can but billions is different than $10 million and you still have all the problems I describe above.
There probably are some really rich 4th or 5th generation Rockefeller descendants. It looks like J.D. Rockefeller had five kids. I’m not tracking down how many children each of those kids had but the number of J.D. Rockefeller descendants could very well be in the hundreds today. If 1% of them are in the 1%, there should be at least a couple of very wealthy Rockefellers today. There are probably many more middle class ones and a few poor ones.
This is where Monte Carlo simulation of outcomes comes in handy to show what the expected distribution of wealth would be over time based on the number of descendants. There is no doubt that inheriting great wealth helps you to become wealthy. I’m guessing some of Rockefeller’s descendants inherited the money, managed it well, and passed a good chunk to their kids. I’m sure there is another bunch that didn’t accomplish that goal either due to mismanagement or just bad luck.
It just won’t work out that way.
So leave it to their children.
Australian university isn’t that expensive.
The wealth itself is almost irrelevant to building up generational wealth. The important part is in teaching your descendants how to manage their assets well, and teaching them to teach their descendants. Do that, and the money will come eventually. Don’t, and even if it does come, it’ll be gone again just as quickly.
Depends on the exact formulation of the rule against perpetuities in your jurisdiction. The classic version is that the trust assets must vest within the lifetime of people who are alive at the time the trust is established (i.e. at your death, if you establish it by will), plus 21 years. If you have a good number of minor grandchildren alive at your death, yeah, you can reasonably expect one of them to live to 70 or beyond, so the trust may continue for 80 years or eve longer, but you could still have great-great grandchilden born outside the trust period who won’t benefit, unlike their older siblings or cousins. And if you don’t happen to have a slew of minor descendants alive at the time of your death, well, the trust period may be considerably shorter than 80 years.
I know it is different in the Game of Life, but in the US at least where he is most colleges are not cheap. And anyone expecting to profit from kids is deluded.
Even if you are lucky enough to have a kid who earns money, the law says you have to stash it away for them.
With average family size hovering around 2, you’re likely to have 2 kids, 4 grandkids and 8 great-grandkids. If you want those 8 to be set up, I would say your best bet is pretty simple. Live cheaply and put it in a mutual fund (actually, I would probably distribute it among a number of different funds that are a mix between aggressive and conservative funds.) Assuming that a mutual fund returns 8 percent which is not unreasonable and that inflation is 3 percent and assume that you live on 80 thousand a year (adjusted for inflation.) I’m going to take a stab and say that you’re 30. When you’re 70, you would have the equivalent of 60 million dollars (inflation adjusted) When you die, you can split that between your two kids and teach them to do the same thing and they’ll die in 30 years as billionaires. They can split it and their kids will be multi-multi-billionaires. The real trick is to be fabulously wealthy and live like you’re upper-middle class.
Can you provide a cite for this? Is it possible to create a legal structure that will hold assets for the purpose you provide for an arbitrarily long time?
I like the idea of education / Kate Middleton’s family. If I give my property to my grandkids (none yet, and none on the radar), they could easily fritter it away. It’d be a nice chunk of change, which could be easily squandered. But if I set up a vehicle that will pay their schooling costs, then if they take advantage of that schooling then they are better set to succeed.
I think the education and opportunity setup will be more successful at raising the tide of future generations than a quick infusion of capital. It’s not a lot of capital, mind you, but itwould pay for some college tuitions.
I’m not so sure about that. It’s my understanding that my grandmother did just that with her beach house. She split ownership among her children, with the stipulation that it could only be passed along to their children.
I don’t know the legal structure, but for all intents and purposes it’s sort of like a tontine, where the last one alive gets everything. I don’t know if that’s legal as it seems to be only used by WWII G.I.s to distribute Nazi gold or other illicit gains in old noir detective stories.
It’s sort of moot anyhow as my Mom was the only one of Grandma’s children who had children of her own (i.e. “me”).
The real best way to build generational wealth IMHO is to have a revenue producing asset, like a family business, that you pass on to your children. They don’t even need to run it. I mean how much day to day involvement does the Walton family or the DuPonts or Paris Hilton have in their family companies?
I was apparently mistaken that more than half of states eliminated it, but I was close. I read that more than half of states had eliminated it years ago. I didn’t check at the time and I didn’t independently confirm the assertion. This guy’s summary shows that at least 23 states currently allow trusts to run for at least 360 years. Fourteen states allow trusts with no defined length (i.e., truly perpetual trusts). https://step6.netlawinc.com/summary-50-state-rule-perpetuities-laws/
Because you can set up a trust anywhere, if one state allows perpetual trusts, you can create one. I stand by my assertion that the rule against perpetuities is no longer the limitation on the OP’s idea. It still won’t work for practical reasons.
I’m not sure what your grandmother did but I think she could have given a life estate to her children and a remainder interest to their children (any particular child, some of their children, or all of them as she saw fit). Since you were the only one of her children’s children, it seems that you got the whole thing. There are a million variations on who could have inherited the remainder interest without violating the common law rule against perpetuities.
Most family businesses don’t survive to a third generation. You can name a couple that have but you would struggle to name any of the tens of thousands over the same period that have been run into the ground by the later generations. I was just talking with my friend yesterday about her great-grandfather’s grocery store. It passed to a third generation (her father) who couldn’t be bothered to run it. He wanted to be an insurance salesman instead so he sold the building.
This article about the state of the Rockefeller fortune is interesting. It’s just anecdotes, but they note that there are 150 J.D. Rockefeller descendants. The fortune has been divided so it’s not quite so significant now. Some in the family are fabulously wealthy but they note that one is a humble cop. With the death of a patriarch, have the Rockefellers lost their power?
A friend of mine had his education paid for (in the 1980s) by a trust established in the 1870s. I’m not sure where the trust was created, but its been going for a while. There are some legal issues with the trust over that period of time - it originally only served biological descendants, but that restriction was, I believe, lifted by the court and adoptive children can be beneficiaries.
It has had the issue of multiple splits and may be finally running out of steam. But they are currently on the fifth generation - going into the sixth. (In todays dollars the estate was worth about $3B)
As far as I know its index funds.
I’m curious about this trust.
I think the rule against perpetuities was in place in every state in the 1870s. Maybe not Louisiana, whose law is based on the Napoleonic code. If the traditional rule against perpetuities applied, then you’d have to consider who was available as a measuring life in the 1870s. Some old family patriarch could have used his then-living grandkids as the measuring lives for the trust. If some of the grandkids were infants in the 1870s, they may have lived into mid-1960s or thereabouts. If the trust vested the remainder of the property in patriarch’s survivors 21 years after the death of the last of those measuring lives, the trust could plausibly have lasted into the mid-1980s or late 1980s, but at that point, the trust would have had to have distributed all its property. It shouldn’t have any money left over now. It’s hard to believe that the same trust is still running today.
It’s also possible that the family money may trace back to the 1870s even if the trust instrument conveying it today differs. For example, 1870s patriarch may have left the money in trust with income to his grandkids for their lives, and principal to their kids 21 years after the death of the last of patriarch’s grandkids. That trust would have also wound down, let’s say in the 1980s, but those great-grandkids (or at least one of them) may have just set up a new trust with the old trust’s assets to carry the family tradition forward. A replacement trust like that could easily survive to the present even with the common law rule against perpetuities.
The trust might be invested in index funds today but it probably wasn’t always. I don’t think index funds were invented until the 1970s.
It might not be the same legal trust, but a new trust, or series of trusts.
I can imagine that a family with dynastic wealth might have some pretty strong intra-family social pressure to reestablish trusts for the future.
Like, if you’re three generations into the trust, and it paid for your elite education, and your parents’, and your grandparents’, and the money gets paid out to you and your 20 cousins along with a hand-written letter from g’g’grandpa, and signed by everyone else who benefited, that says “Hey, legally, this money is yours, but do right by your family and make a new trust to continue the tradition”, I bet that works pretty well a lot of the time.
And if a few of those cousins don’t want to chip back in, you can just exclude them and their progeny from the new trust.
The results of the 1832 Georgia Cherokee Land Lottery proved that randomly awarded financial wealth doesn’t persist after the first generation:
And in the book The Son Also Rises (The Son Also Rises (book) - Wikipedia) Gregory Clark shows that social mobility essentially doesn’t exist, as families who had elite surnames centuries ago are still overrepresented among elites, and people with peasant surnames stay in poverty for generations.
Genes matter. You need to get access to to people with better genes in order to wealth within a family for generations.
The thing about split-twin studies is that usually both of the twins are adopted, with both adoptive families passing the regulatory requirements to adopt a child. So the families are more similar than random-chance birth families would be, skewing the results a bit.
The problem with earnings from real estate is that it’s earnings from rent. And that means that you have to deal with renters. That is not a small thing. Even if you hire property managers, it’s still not a small thing.
What happens when people come into large sums of money is not really at issue here, since the trust would be set up to prevent the heirs from frittering it away. The number of descendants is far more of an issue, since we can breed far faster than interest can accrue. One or two descendants a generation might work, much more than that and you have a problem.
Airline pilots can’t afford a good university there? I thought the U.S. was supposed to be the most expensive messed up place to afford a higher education, but the average airline pilot earns more than double my parents’ household income ever was and I had siblings go to upper-tier private schools.