Life Insurance Creates an Inheritance, Not Generational Wealth
For high-earning couples who have spent decades accumulating assets, one of the most common measures of financial success is whether they will eventually leave something meaningful behind for their children. And for many, life insurance is expected to play an important role in accomplishing that goal.
A large life insurance payout can create a multi-million dollar inheritance overnight, making it entirely possible for parents to leave their children in a much better financial position than they were in at the same age. But leaving behind a large inheritance and creating generational wealth are not necessarily the same thing.
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Life insurance is one of the fastest ways to create a large inheritance, but the death benefit itself does not produce wealth that continues creating opportunities for multiple generations. Instead, generational wealth emerges only when the people receiving the money are prepared to preserve, protect, and grow it for those who will follow.
If a couple, for example, were to pass away and leave their adult children $5 million worth of life insurance proceeds, whether that inheritance leads to generational wealth or not depends entirely on what happens next.
By anyone’s definition, those adult children would have just inherited a life-changing sum of money. Depending on their financial circumstances, that money has the power to eliminate their debts, fund their children’s education entirely, and allow them to retire at least a full decade earlier than they may have planned. But if instead they were to treat the inheritance as permission to upgrade their lifestyle indefinitely, the likelihood of that wealth transfer being perpetuated is very low.
Teach Your Children to be Stewards of the Wealth
The first generation in an affluent family typically has a very different relationship with money than those that follow. Even when wealth appears to have been created quickly through an initial public offering or the sale of a business, years of work and immense sacrifice usually have preceded the payoff.
Their children, however, experience something entirely different. In many cases, they simply receive the finished product, which creates an unusual challenge. The skills required to accumulate several million dollars are not automatically transferred alongside the assets, making it paramount that families interested in creating generational wealth teach their children to see themselves as stewards of the family’s assets rather than mere beneficiaries of them.
While a steward can (and should) benefit from the money, this approach also introduces additional responsibility. Rather than looking at the inheritance as something that will enhance their own lives, stewardship requires them to also think about how they can create opportunities for the people who will come after them. That one subtle change in perspective can completely alter their financial behavior for the better.
Build Guardrails Around the Money
While your adult children may be well educated, responsible, and even financially sophisticated, it is still entirely possible that they might make a bad investment, get sued, or go through a protracted divorce. Therefore, creating generational wealth requires infrastructure.
Depending on the family, its size, and overall complexity, there could be a need for sophisticated trusts and entity structures or beneficiary designations that are regularly reviewed and updated. In any instance, the objective should not be to control your adult children from the grave.
Instead, the goal should be to make the family’s wealth more resilient. Think of these structures as financial guardrails designed to prevent one bad decision or unfortunate circumstance from permanently impairing the wealth available to future generations.
There is also value in putting guardrails around the amount of wealth that reaches the next generation at a single time. Receiving several million dollars overnight can change a person’s perception of what they can afford long before they have developed the experience necessary to manage that gift responsibly. A trust that provides access to the money gradually—or under certain circumstances—can allow them to benefit from some of the money without immediately putting the entire family fortune at risk.
Start Preparing Them Before They Inherit Anything
Perhaps the biggest flaw in the traditional approach to estate planning is that so much of it revolves around preparing the assets for the beneficiaries rather than preparing the beneficiaries for the assets. The generation creating the wealth tends to spend countless hours with their attorneys deciding how trusts should be structured and how assets should be titled. But far fewer people spend time teaching the next generation of their eventual expectations.
If your family has accumulated enough wealth to require an estate attorney, a CPA, a financial advisor, and an insurance professional, your children should not be introduced to those people for the first time at your funeral. They should at least know who helped construct the plans, where the assets are located, and have some familiarity with the family's financial positioning.
Those conversations do not need to begin by disclosing the exact amount your heirs stand to inherit; younger children likely do not need to know the specifics. The most important lesson is establishing a family philosophy around wealth as early as possible.
They should understand how the family thinks about saving, investing, debt, charity, lifestyle spending, and financial independence. And as they age and demonstrate greater financial maturity, the conversations can become increasingly more specific.
This also gives parents an opportunity to observe how their children handle financial responsibility while they are still around to provide guidance. Giving an adult child responsibility for a much smaller financial gift today can reveal far more about their financial judgment than simply hoping they will know what to do with several million dollars later.
True generational wealth requires something more difficult than simply being born into the right family. The generation receiving the assets must be capable of preserving and ultimately growing them beyond the original principal. Otherwise, every subsequent generation begins with a smaller asset base until, eventually, there is nothing left to transfer.
This is why purchasing more life insurance, accumulating a larger investment portfolio, or simply working a few additional years cannot solve the generational wealth problem alone. At some point, the family creating the wealth must spend the same amount of time preparing the people who will receive the money as they spent accumulating the money in the first place.
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Malcolm Ethridge is the Managing Partner at Capital Area Planning Group, based in Washington, D.C. His areas of expertise include retirement planning, investment portfolio development, tax planning, insurance, equity compensation and other executive benefits.
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Disclosures:
The information provided is for educational and informational purposes only, does not constitute investment advice, and should not be relied upon as such. Be sure to consult with your tax and legal advisors before taking any action that could have tax and legal consequences.
Investments in securities and insurance products are:
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