Julie and Mark (not their real names) worked hard to make sure their three kids wouldn’t grow up feeling “entitled”—insisting, among other things, that they get summer jobs in their teens.
Nevertheless, the couple is saving up to give the kids a financial boost. The reason? Even with two of them now launched on promising careers and the third in college, Julie and Mark realize their own steady career paths—she’s an educational therapist, he’s a hospital administrator—are increasingly rare. Jobs come and go in today’s “gig” economy. Industries get disrupted.
And if, years or even decades down the road, one of their children wants to start a business or struggles to put his own kids through college, Julie and Mark plan to help—even if they aren’t around to do so directly.
In short, they’re building a financial legacy.
Want to do something similar for your own family? Here’s how you can do it.
Choose a strategy
Many anticipate leaving money to their kids, but may end up doing the opposite, such as burdening them with accumulated debts or late-in-life medical expenses. Do your offspring a huge favor and consider focusing first on ensuring a comfortable retirement for you and your spouse.
If you’re on track to cover your own needs, and you still have financial bandwidth to spare for a legacy, weigh your options:
- Guarantee income. Maybe you want to be certain of leaving behind financial assets. (Parents of kids with special needs often feel that urgency.) In that case, consider if purchasing a life insurance or an annuity—either of which can be structured to generate a lump sum or income stream to your survivors when you die, may be right for you, says Brandon Buckingham, director of Prudential Annuities’ Advanced Planning Group.
Taking no chances can come with costs. For example, these products can be complex, they come in a variety of flavors, and their prices can vary. Also, your money’s growth potential can be limited, so your beneficiaries may find they’d have been better off if you’d invested in stocks instead. (But remember, peace of mind has its advantages—like avoiding the market’s roller coaster ride.)
- Be flexible. Retirees typically draw down their savings over the course of their lives, aiming merely not to run out early. (A 4% annual draw on principal is one traditional strategy.) But as a legacy builder, you may want to live off only the income generated by your savings, and leave the principal untouched for the next generation. That requires more savings in advance, of course, but ensures that you’ll have money left to pass on regardless of market conditions (or for emergencies).
- Divide and conquer. Another approach is to split your financial and nonfinancial assets, living on one and keeping the other in reserve for your heirs. Some retirees, for example, live off their savings and plan to leave a home or a vacation home to their kids. That can be effective—but keep in mind that many Americans end up tapping their home equity to cover retirement expenses. So if you hope to leave your home free and clear for your kids, you should consider excluding it when you project the size of your retirement nest egg.
- Invest for the long haul. As savers approach retirement, many financial professionals suggest that they consider beginning to shift the asset allocation of their investment portfolio from one weighted heavily toward stocks, which tend to carry more risk, to one more weighted toward cash, bonds, and other fixed income assets. The reason: Stocks tend to be more volatile than bonds, and you may want to decrease the odds of cashing out during a stock market downturn to pay your living expenses—thereby locking in investment losses.
Legacy builders may want to consider another approach, however: With money you expect to pass on to the next generation, you may not need to limit your exposure as much, and may be better off leaving more of the assets in stocks; while there is more risk, stocks have higher expected returns over the long term than bonds. And your kids should have more time to ride out short-term market volatility.
If you have a family business, a trust may help you pass it on without triggering a giant tax bill.
Whatever strategy you decide remember investing involves risk and it is possible to lose money when investing. Asset allocation does not assure a profit or prevent a loss in declining markets. You should consider a variety of factors when deciding how to invest to meet your financial goals; such as your time horizon and risk tolerance.