Delusions of Immortality

Jonathan Clements  |  August 5, 2017

We are all constrained by the income we have and the wealth we’ve either amassed or had handed to us. Result: Those on low incomes struggle to cover daily expenses. The middle class pay for today, while also socking away money for their own future. What about the rich? They often use their wealth not only for themselves, but also to help future generations.

These are, of course, gross generalizations. Some folks on low incomes manage to save surprising sums for their own retirement. The middle class may not bequeath great gobs of money to their children, but they often help with college costs. And, over the years, many spectacularly rich families have shown an alarming ability to devour wealth, leaving precious little for their children and grandchildren.

Still, I am fascinated by the possibility of helping future generations and the small sliver of immortality it offers. “I never knew my great grandparents, but I couldn’t have gone to college without their foresight,” has a nice ring to it. We may be gone, but it’s comforting to think we aren’t totally forgotten.

I have helped my children financially—a topic I have written about frequently. But what about subsequent generations? When I first pondered the issue, I had high hopes: I might not be able to commit significant sums to help later generations, but decades of investment compounding could potentially compensate.

But the more I’ve thought about it, the less promising the prospects seem—and the less surprised I am by the disappearance of great family fortunes. That doesn’t mean we shouldn’t try to help future generations. But our impact is likely to be limited and short-lived, for two reasons.

Problem No. 1: The math is against us. Efforts to pass wealth down through the generations face two obstacles: rising living standards and growing families.

As investors, we often focus on outpacing the twin threats of inflation and taxes. If we aren’t overcoming those two threats, our money isn’t growing. Seem reasonable? In truth, it’s a tad more complicated.

Our national standard of living is pegged not to inflation, but to per-capita economic growth. Over the past 50 years, U.S. per-capita economic growth has climbed at 1.8 percentage points a year faster than inflation. In other words, if our income rises with inflation, our standard of living might stay the same, but we’ll feel increasingly poor compared to our ever more affluent neighbors.

This need to keep pace with rising living standards creates big problems for family fortunes. Imagine we bequeathed $1 million, with the goal of generating income for our family in perpetuity. Our heirs invest the entire sum in stocks, an obviously risky strategy, and we’ll assume they incur no investment costs. Stocks go on to earn 6% a year, or four percentage points more than the 2% annual inflation rate. That’s a reasonable long-run forecast for stocks, I believe.

“Money doesn’t necessarily kill all ambition. But it seems to put a big dent in financial ambition.”

In the first year, the $1 million we bequeath earns $60,000. Federal and state income taxes would be owed. Let’s say that amounts to a combined rate of 18%—15% for federal taxes and 3% for state taxes—leaving our heirs with $49,200.

Our heirs would need to reinvest a chunk of that money to keep the portfolio growing. How much should they reinvest? Suppose the goal is to ensure the portfolio kicks off an income stream that rises not with the 2% inflation rate, but with per-capita economic growth. If per-capita growth continues to expand 1.8 percentage points a year faster than inflation, our heirs would need to reinvest $38,000. That would leave just $11,200 to be spent—a 1.1% withdrawal rate.

The good news: If our heirs stick to that 1.1% annual withdrawal rate, both the $1 million and the income it generates will rise every year along with per-capita economic growth, and it’ll do so in perpetuity. The bad news: Our heirs will receive pitifully little income.

To make matters worse, there’s a good chance we’ll leave behind a growing clan. Let’s assume we have two children, they each have two children, and those children each have two kids. That means we will have eight great grandchildren, all vying for their piece of the 1.1%.

You don’t need to be a genius to figure out what happens: A whole lot more than 1.1% gets spent, at which point the money we left behind won’t last in perpetuity. Instead, it will be depleted, slowly at first and then ever faster, as the demands for income outstrip the portfolio’s investment gains.

Problem No. 2: Money saps financial ambition. Potentially, our goal of helping our family in perpetuity could still come to fruition—if our heirs viewed their inheritance not as a financial mainstay, but as a nice annual supplement to the income they earn from their jobs.

On that score, however, we’re running up against human nature. Money doesn’t necessarily kill all ambition. But it seems to put a big dent in financial ambition.

I see this with my own children and stepchildren. They won’t inherit huge sums and don’t expect to. But they have grown up in comfortable upper middle-class households, and that’s had an impact.

How so? They all seem to be ambitious—but they don’t appear to be especially ambitious when it comes to making money. You can find that raw moneymaking desire among kids from affluent homes, but you’re far more likely to see it among those who grew up with too little.

I’m heartened that my children and stepchildren are, for the most part, careful spenders. That should help them avoid major financial headaches. But what about their lack of financial drive? Initially, I viewed it with some concern. But over time, I have come to see it as a luxury that comes with affluence: They worry less about money than I did, when I was their age, and that strikes me as a good thing.

Indeed, I have come to believe that, as long as they devote their days to work that benefits those around them, they are leading good lives, even if they aren’t collecting big paychecks. But there’s an obvious financial impact: To the extent that I leave them money, it’ll likely be spent and not passed along to the next generation.

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