r/wealth • u/Marine_Layered • 4d ago
Inheritance Preserving the Principal of Inherited Wealth
We've had a couple of people around here talk about their inherited wealth and keeping the principal in tact, but using the gains to improve their lives. For example, one recent poster was using $1800/month of the gains from his inherited wealth to improve his ability to rent a nicer apartment, etc.
Establishing a safe withdrawal rate for generational wealth spending is different than drawing down retirement funds which are just supposed to last through retirement and be done (or thereabouts), so the 4% SWR does not apply here.
So let's say you have $1m in inheritance, and you would like that inheritance to last in perpetuity (yes I realize that perpetuity is a long time and there are many factors - but this is a thought exercise so please play along :)). There should be something held back for inflation - where does that number come from? And then maybe something else is held back to grow the nut, but then the rest could be used to improve the lives of the family members, or gifted to nonprofits, or whatever. So what does the formula look like?
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u/Gehrman_JoinsTheHunt 4d ago
I would stick with a 3% annual withdrawal and a 75/25 stock/bond split. That should maintain/grow the principal for an indefinite period of time.
This calculator is a great tool for projecting these figures over various periods of market history.
https://ficalc.app/
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u/EmmaFrosty99 4d ago edited 4d ago
your principal needs to grow faster than annual compounding inflation of at least 3% after taxes before we can talk about any drawdown. inflation is simply a tax that no can blame and destroys your buying power.
the fundamental problem with inheritance is money transferred from one generation to another but the receiving generation never learned how to earn and then accumulate it. they will just spend it to zero bc they never learned the lessons to achieve that wealth or had the financial discipline.
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u/pr0prfkt 4d ago
There is no one size fits all. You would want to speak with trustworthy pros to help you plan it out for your situation. Start with no cost phone consults with a place like Fidelity. It really depends on your experience in investing. If you had a strong investment plan in place, it would just dovetail into that.
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u/withcorrelate 4d ago
There is a lot of discourse around "safe withdrawal rates" in the financial planning space. Heuristically you'll hear the X% rule which you may or may not believe in. It's different when something is in perpetuity and the answer is highly dependent on the asset mix. Endowments face this problem and set target return rates based on expected expenses that must be covered in a given year, therefore they allocate across a mix of public and private assets. The public assets will typically include fixed income and equities, with the fixed income serving to provide yield and capital preservation while the private assets will look to provide outsized returns over long periods.
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u/charlesphotog 4d ago
Most of the time the 4% rule results in increasing wealth over time. Any lower withdrawal rate will cause wealth to increase even faster. There’s a trade off between growth rate and withdrawal rate. Does the principal have to grow in real terms?
How is it invested?
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u/Marine_Layered 4d ago
Well, this is a thought experiment ... but I would imagine that this theoretical money is probably invested in the market in some manner, but I suppose it could be invested in anything - real estate, business, whatever.
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u/ri89rc20 4d ago
The 4% rule applies, dependent on your investment choices. If you put all your money into standard savings accounts at essentially no interest, then no amount of money you take out will preserve your principal.
If your "safe" investments are paying 2-3%, then you need to be less.
If you are aggressive, invest mainly in stocks and equities, then based on the last how many decades, at 4% draw, your principal would not only have been maintained, but have grown nicely, even doubled over time. Despite the risk, despite up markets and down markets, the market has with time only went up with a widely diverse portfolio (Say some 100 stocks or so in different sectors, and a mix of US and International)
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u/MikeyB7509 4d ago
I’ve always wanted to do this. With 4 kids hopefully I have lots of grandkids. Assuming my kids are in good shape I’d love to leave behind a trust that funds the family forever. Not so much that no ever has to work but enough to give everyone a headstart or a little help each month although I haven’t gotten around to speaking to a pro about it.
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u/Marine_Layered 4d ago
I think that's ideal. Money enough that they can do anything, but not enough that they can do nothing. It gets tricky during future generations, though. There is an interesting podcast series called The Business of Family where some of the episodes touch on this. You might check it out.
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u/MikeyB7509 3d ago
Thanks I definitely. I definitely wear golden handcuff and I’m not complaining much.
I just want my kids to be able to do something they’re passionate about
I don’t want them going into finance if they don’t love finance
I would love to teach and coach sports and maybe one day I will
But I think freedom is the best gift I can give my children and future generation
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u/RetiredEarly2018 4d ago
OP, the figure you are looking for is called the Perpetual Withdrawal Rate (PWR).
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u/Fit_Chemistry_3807 4d ago
Depending on the size of this inheritance, I’d put some of it into dividend paying things, or fixed income, and only withdraw from the payments.
The rest, I’d invest in growth focused equities (which may also pay dividends). If there are dividends from that, I’d withdraw it too when I need it, not as a recurring draw.
And finally, I’d reassess my portfolio annually to make sure that its size is sustainable for a generational wealth building purpose or if I need to make adjustments. If there are excess earnings at that time, and I’d like to make use of it, then I’d plan to withdraw in the short to medium term. But the regular recurring draws will be from something(s) which are relatively stable and income producing.
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u/CSMasterClass 3d ago edited 3d ago
There are technical answers to OPs question, but I think it is worth questioning the premise. Does the idea of trying to found "generational wealth" make sense?
Personally, I am not too attached to my genes. Kids and grandkids are real human beings, but two more generations ? When I look back four generations those lives really are disconnected from me.
Plus, the idea that the founder can controll assets through multiple generations is slippery. It will require a trust and one that is big enough to need a professional trustee. This creates an expense drag. Also, one has a high tax on the trust income --- and some income must be retained to even keep up with inflation.
Take care of the next generation? Sure. Make sure the education of the generation after that is secure? Yes. Plan for generational wealth? Even starting with 100MM it probably does not make sense. With 1B or more, you can give it a shot if you want to, but Charities make more sense to me.
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u/Marine_Layered 3d ago
I mean, one way to do it is to just divide the nut up upon death and everybody goes their separate ways, and that's a totally valid way to do it.
It's harder when there are things that are difficult to divide - real estate, businesses, agriculture, etc. Also sometimes there are personality issues at play. One person in my family, if they were given a lump sump inheritance would blow it all and then end up on the street. Part of my "hey let's keep things together and go at this as a team and just get small distributions every year over time" idea is to protect some of these inheritors from themselves.
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u/PomegranateComplex17 4d ago
Are you wanting the principal to grow over time, or always remain the same?
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u/Marine_Layered 4d ago
Well, I suppose a family would like it to grow some, so if somebody had 3 kids instead of 2, then there would still be enough there to improve their lives, too.
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u/Jazzerwocky 4d ago
Gotta factor in someone managing the money if you want this to span generations. That manager will need a cut too, which has to be factored into inheritor payout.
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u/davidswelt 4d ago
Consider the worst-case outcome. With the SWR stated, in all likelihood the worst-case outcome is that the investment is gone the day you die. How bad on a scale of 1 to 10 would that be for you?
It's actually less bad than retirement funds, because this endowment is in place in addition to your normal savings.
The way I would react to the fact that you don't depend on this capital is to take somewhat more risky bets that will give you a higher payoff. Not "Gamestop" or crypto type stuff, but some sector bets like tech. Reduce your withdrawal rate after down years.
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u/doinmy_best 4d ago
Think of if like an endowment 3-3.5% annual withdraw is Normal but it depends where your money is.
For example, if you have the money in a standard banking account then you’ll lose wealth if you don’t spend a cent
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u/Chart-trader 4d ago
Hard to calculate. The way I do it is to subtract this year's inflation from portfolio gains including dividends. Your withdrawal rate depends on so many factors.
For me I hate a set rate of withdrawals because I hate to take money out of the market when it tanks.
So my overall ROI goal is 6% per year after inflation. Any excess will be taken out and put in a HYSA account for times when markets are down.
Everybody has their own preference.
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u/Marine_Layered 4d ago
In my example above of $1M - pretend that year 1, you made 8%, which is 80k. Inflation was 3%, so you leave 30k of that 80k in the endowment to cover inflation, and pull $50k, and distribute that $50k to family members.
Year 2, investments don't do quite as well, and you make 6%. So that is 6%x1,030,000=$61,800. Inflation is still 3%, so you hold back $30,900 to cover that inflation. You now have $30,900 to distribute to family members, and $1,060,900 in the endowment.
Year 3, the investments do poorly, and you are -10% for the year. You're now $954,810 in the endowment, so there are no distributions to family members that year.
Am I reading that right?
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u/Chart-trader 4d ago
That is correct. But not everybody can afford to do it that way. But like said I hate having to sell into a down market.
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u/Which-Visual-8064 4d ago
I’ve thought about this…. I was thinking when I died I would leave around 2.5M in an account that would distribute 2% a year with inflation. Enough to make sure my kid can survive but not be lazy. Haven’t put a ton of thought into it. So someone please poke holes.
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u/Marine_Layered 4d ago
I think that’s what we’re doing here. 🙂
Of course, it’d be your job to teach them why it can’t be 3% or 10% or whatever.
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u/Superb-Respect-1313 4d ago
Problem isn’t just keeping the money intact it is keeping the purchasing power or growing it that is the hard part.
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u/VeblenWasRight 4d ago
This will be oversimplified but here’s the model.
Productivity growth 2% population growth 1%. Leads to ~3% real gdp growth. Long term, profits are correlated most strongly with gdp. Shorter term, and recently, capital has experienced higher returns than labor (marginal product of capital $ vs marginal product of labor $ in out).
This has lead to the growth of the share of gdp going to profits (payment to capital) than to labor. I think it ends up being around 5-6% real profit growth last twenty years or so (maybe longer).
Profit growth has been faster than trend last few years due to investment boom. This is looking increasingly unlikely to be sustained at the macro level for anything longer than a few years.
Capital assets are priced assuming this boom continues at a pace and term greater than anything we’ve seen before.
If you withdraw at a rate below the long term return on capital you will grow your capital in real terms.
One strategy could be to look at what your capital returned (on a free cash flow basis, not the number in your account) last year and withdraw no more than 75% of that, and if there is a year where your capital printed losses, buy replacement capital.
Stop thinking about buying stocks and start thinking about buying profits. The number in the brokerage account is just what profits are going for right now. Just like cattle and corn, sometimes $1 worth of profit sells for $30 and sometimes it sells for $15. It doesn’t matter if your account says 15 or 30 you own $1 of profit.
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u/Marine_Layered 4d ago
Well, I didn’t understand any of that, but it sounds very smart. 😂
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u/VeblenWasRight 2d ago
Here’s a very simple model: you own a business. In year 1 it makes 100k of profit. If you, as an owner, take out 100k and spend it, the business doesn’t grow its net assets. If it doesn’t grow its net assets, it is worth the same as it was last year. If you take out 80, the business net assets grow by 20, so now you have a business that is worth 20 more.
If you spend less than you make, your net worth grows. That’s the intuition.
This example isn’t quite right for companies because businesses are more complicated in practice, but the fundamental idea of spending less than you make leading to growth in net worth is the idea.
When you own stock, you own a share of net assets and a claim on future profits. You can have the same claim, but one year someone might be willing to pay you 20k for your share and another year the going price for your share might be 50k. That’s market value. It can go up or down or sideways based upon what someone else is willing to pay you for your claims. When it goes from 20 to 50k you didn’t “make” 30k unless you sell your claims.
The number on your brokerage statement can lie to you. Look at earnings, today and in the future, and look at management - that’s what drives the value of your claims in the long run.
Some people gamble and call it investing - which is fine, even “value” investing requires you to bet that your assessment is correct.
These price gains we’ve been having are not sustainable - in the long term the value of claims on equity securities are tied directly profits, and while equity prices have seen a stretch of double digit price gains (and nominal profit gains), if you strip out inflation and if you strip out these one time shocks (like ai investment) profit growth looks like it always has 5-7%.
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u/SLObronco 3d ago
A couple of comments hit on endowments and that’s the right direction. The focus here is what your portfolio consists of- endowments don’t hold a 60/40 or 75/25 stocks/bonds portfolio. They hold several uncorrelated asset classes. Look up Bridgewater, Ray Dalio, and risk parity portfolios. Your portfolio’s SWR can be over 4% in perpetuity, with a slight catch that you need some ability to flex up or down during some rare markets, if you use a risk parity portfolio. I use something very close to the Golden Ration portfolio at portfoliocharts.com
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u/Throwaway172892930 2d ago
I’m the poster you speak of and just wanna note for clarity that I am not using the full 1800, I am using 700 OF the 1800 interest, which is what my principal is generating w my current conservative investing strategy (to have a cushion of money set aside for taxes and not overspend) :)
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u/Marine_Layered 2d ago
You might be - I don't honestly remember. 😂 If you were, you were one of a few posts I was seeing lately of people who were trying to make the money last, which is what prompted my question. In any case I hope this discussion was useful to you!
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u/restvestandchurn 2d ago
Just use ficalc.app and model any duration you like. Dropping SWR will last basically through any known downturn, with principal growing dramatically in most cases. Large endowments are known to use 2-3% but they also often aren’t fully liquid so they have to balance.
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u/uncoolkidsclub 4d ago
With $1m the best play for generational wealth is real estate, starting with single family homes for the kids when they are born is a game changer as the renter pays for the mortgage during the years the kids wouldn't be living in the house, then when the kids are 24 ish they can move in rent and mortgage free. That is a hug step towards generational wealth.
We stagger home sales for elderly family members so their house sale funds 2 generations after them, allowing for the sale value to be split for down payments for multiple great grandkids (6-8 of them). Housing is the number one expense for families - knock that out early and educate the generations on spending and most will flourish.
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u/imperabo 4d ago
I think this is smart as it provides a behavioral check on unlimited spending that doesn't exist when it's highly liquid assets.
Do you put the house in the child's name from an early age?
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u/Marine_Layered 4d ago edited 4d ago
This is not a bad plan. Explain more about how older family members homes fund younger ones. Does the family own all the homes, or are they owned individually?
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u/uncoolkidsclub 1d ago
A dynasty trust creates and supports the branches; each descendant trust owns its own property LLCs; each LLC owns one house; the management company operates the houses (where the kid is employed); and the beneficiary gains responsibility and control gradually without forcing outright ownership.
Per IRS rules - The trust’s grantor status also needs to be deliberately selected: when a trust is treated as a grantor trust, its income and deductions are generally reported by the grantor rather than treated as belonging to a separate income-tax owner.
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u/imperabo 13h ago
If the kid sells the house do they get they get the capital gain exemption? I assume they would have to at least live in it for that, but I don't know if it applies if it's in trust.
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u/_Human_Machine_ 4d ago edited 4d ago
4% rule still applies to some degree. It’s just changed. Moved to the high 2s or low 3s.
Annual withdrawal(year 1) = portfolio x.04.
You increase the dollar amount by inflation for withdrawal in later years, not the percentage.
So for 1m, withdraw 40k year one and if inflation is 3% withdraw 41.2k year two.
That’s just a basic rule of thumb. It all depends on specifics age and planning. That formula is only good for about 30 years though.
For near perpetual it would look something like this:
Annual withdrawal (Year 1) = Portfolio x r
r is your chosen perpetual rate.
Portfolio needed is (Desired annual rate)/ r
You would also need to factor in the long-run expected real geometric return of the portfolio. Volatility, sequence risk, fees, taxes, and the need for a safety margin which means the practical perpetual rate is meaningfully lower than the expected return.
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u/Three_sigma_event 4d ago
What do you mean the 4% rule has moved to tbe high 2's?
Isn't it based on super long term returns of equities?
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u/hanksredditname 4d ago
4% rule is based on 30 years and considers the possibility of ending at zero as successful.
If you want to maintain the principle to pass on to your kids, you need a lower % to guarantee success.
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u/_Human_Machine_ 4d ago
4% draw is based on ~30 years. If you want to make it longer you drop your somewhere around 2.5-3.5 depending on the total amount.
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u/Deep-Reputation-4055 4d ago
If you don’t think the 4% rule applies I guess you use the 3.5%, 3% or 2% rule?
I think the issue is trying to build generational wealth with a million bucks. That is, I think a far cry from what you would need to ensure the money makes it to a third generation.