A Plan to Grow Wealth and Save Millions in Income Tax Over Multiple Generations

Monument to Cornelius Vanderbilt at Grand Central Station

 

How Reckless Spending and Estate Taxes Wiped out a Family Fortune:

One of the richest people to have ever lived was William Henry Vanderbilt. In fact, at the time of his death in 1885, William Henry Vanderbilt had amassed a fortune of what would be worth over $230 billion in today’s dollars. Less than ninety years later, the majority of that fortune had all but disappeared. Let’s take a look at the Vanderbilt story to see if we can learn the lessons of the past so that we aren’t doomed to repeat them.

William’s fortune had all started with his father, famous industrialist Cornelius “Commodore” Vanderbilt. Commodore Vanderbilt was a ruthless and savvy businessman who had built up an empire composed of railroads, shipping, and real estate. Thanks to his business acumen, the Commodore was all too aware of the fact that family fortunes could easily be lost by future generations. Given this knowledge, the Commodore had carefully groomed his son William to manage the family fortune. In fact, despite having twelve children, Commodore Vanderbilt left over 90% of his estate to William for the sole reason that he believed that William was the only one capable of not only maintaining the family fortune, but also growing it. William did not disappoint. In fact, he more than doubled the family fortune after his father’s death. Unfortunately for future generations, William had not been as careful as his father had been with regards to teaching his children about wealth and his estate planning. Neither were many of William’s descendants. According to the book Fortune’s Children: The Fall of the House of Vanderbilt, less than 90 years after William Vanderbilt’s death, when 120 of his descendants gathered at Vanderbilt University for a family reunion, there was not a single millionaire among them.

There’s a popular saying in finance circles that the first generation makes it, the second generation spends it, and the third generation blows it. In fact, an article in Money magazine recently indicated that 70% of wealthy families lose their wealth by the second generation and 90% of wealthy families lose their wealth by the third generation. A large reason for this is that many people don’t talk to their kids about the importance of saving, the importance of proper investing, and the importance of living within one’s means. The book Fortune’s Children talks in great detail how the descendants of William Vanderbilt spent much of the money on extravagant lifestyles, opulent homes, and large mansions, while doing little to grow the family fortune. By the late 1940s, most of the large homes had been reduced to rubble and their contents auctioned off. There’s also little doubt that the introduction of income taxes and estate taxes in the early 1900s took a hefty toll on the Vanderbilt fortune.

 

Grow Your Estate and Save Taxes for Generations

With all this in mind, I’d like to present a plan to ensure a successful transfer of wealth from one generation to the next that could also result in millions of dollars in tax savings over multiple generations.

Granted, for this plan to work a family would need to a have accumulated a certain amount of wealth to begin with. Moreover, this wealth would need to be available to pass on. My guess is, however, that if you are reading this blog, there is a good chance you’re on your way to building enough wealth to make use of this plan. How great is that? You sacrifice a little bit and save and invest your money so that eventually you can enact the plan below and, as a result of all your hard work, you ensure intergenerational wealth for generation after generation. Perhaps, one hundred years from now your descendants will have their own great family reunion and all your wealthy grandchildren and great-grandchildren will gather to pay homage to your wisdom, sacrifice, and foresight.

 

The Plan

My plan to bestow wealth on your family for generation after generation is for you to simply contribute to your adult children’s tax free retirement savings plans each year and then have them do the same for their children. You would make these investments in low cost ETFs that mirror the S&P 500 index.

Far from being an elaborate or complicated scheme requiring accountants, lawyers, or financial geniuses, the beauty of this plan lies in its simplicity. Anyone can understand and implement it. In fact, the simplicity of this plan reminds me of a quote from famous money manager Peter Lynch, who once said, “Never invest in any idea you can’t illustrate with a crayon.”

Let’s take a look to see how this plan could end up working out for me and my family. Given I have two children, and assuming I gift each child $5,000 a year, this plan will require me to free up an extra $10,000 a year once my children become adults and become eligible to contribute to a tax advantaged retirement savings account.

Let’s assume I start making these investment when my children turn 18 years-old and that I continue making these investments for 20 years, up until their 38th birthday. Let’s also assume I make these contributions into Roth IRAs (or TFSAs if you are from Canada). These types of retirement savings plans would ensure that the contributions get to grow tax free and also get to be withdrawn tax free. Following this strategy would mean that in total, over the course of 20 years, I will have gifted each child $100,000. Now I know that sounds like a lot of money, but assuming I would have been able to leave an equivalent amount to my children upon my death ($100,000 each), let’s see how a scenario that involves paying them a little bit of my estate each year, while I’m alive, would pan out.

Assuming the S&P 500 delivered a compound annual growth rate (CAGR) of 7% (including reinvestment of dividends), each child would have roughly $225,000 in their accounts on their 38th birthday. If my children then did nothing else but allow these savings to compound tax free, each one would end up with roughly $870,000 by the time they turn 58 years-old. Moreover, assuming the S&P were to continue to deliver a 7% CAGR, each child would then have a tax free income stream of roughly $60,000 a year. Now that’s not too shabby. Especially when it is compared to each child simply getting a onetime payout of $100,000 at the time of my death. But hold on, we’re not done yet. Let’s now assume my children then use some of this income stream to pay it forward to their children (my grand-children) by contributing to their retirement savings accounts as well.

The whole scenario could play out something like this – assuming each of my children were to get married and have their own children on their 40th birthday, it would mean that by the time each of my children reached 58 years-old, their children would turn 18 years-old. Given my children would be 58 years-old, they should have built up roughly $870,000 in their tax advantaged savings accounts and should have access to roughly $60,000 a year. This being the case, my children could now start withdrawing the tax free money in their retirement savings plans and use a portion of it to contribute to their now 18 year-old children’s retirement savings plans (my grand-children’s retirement savings plans). This cycle could theoretically continue for generation after generation.

In addition to ensuring this money gets invested intelligently (you only gift it if your children agree to contribute to their Roth IRA and not squander it) and to creating a perpetual income stream for future generations, this plan could also result in millions of dollars in tax savings over future generations. In the example above, by investing in the Roth IRAs, each child will have saved hundreds of thousands of dollars in income taxes. Depending on the size of my estate and the estate tax at the time of my death, I might have also saved estate taxes on close to $2 million, assuming I had just invested the money myself and had not given it to my children to invest in their Roth IRAs. It’s not hard to see how this strategy could potentially add up to millions in savings when applied over many generations.

My hope is that I will have been successful enough at teaching my children about money that this plan will enable them to use their own money to pay down their own mortgages and student debt faster and, therefore, avoid losing large amounts of their money to interest payments. Once they successfully pay these debts off and I stop contributing to their Roth IRAs on their 38th birthday, they can then start making these retirement contribution themselves.

So there it is, my plan to ensure intergenerational wealth and save millions in taxes over many generations. Sure it’s not going to make my kids as rich as Cornelius Vanderbilt was, but at least it might end up better for them than it did for some of the Commodore’s descendants.

2 Comments

  1. I love the history lesson that you tied into the article. It’s truly amazing how quickly a generation can spend money. I don’t know if you read the book Empty Mansions about Huguette Clark but it is astounding how the rich can isolate themselves and spend.

    • Thanks MSM. Yeah, it’s all to easy to lose a fortune. I’ll leave you with another quote from Cornelius Vanderbilt – “Any fool can make a fortune; it takes a man of brains to hold onto it once it has been made”. I’ve taken an interest in reading about some of the wealthiest people of all time and finding out how they made (or in this case lost) their fortunes. Haven’t read “Empty Mansions” but it sounds like its right up my alley! Thanks for the recommendation I’ll definitely try and check it out.

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