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July 17, 2007

A Better Safety Net than Social Security for Your Kids

When my daughter was born three years ago, it started me thinking: If I put aside $2,000 a year for her, how much of a difference could it make during her lifetime?

If the market does as well over the next 70 years as it has the past 70 years, it will average about 11% a year. So by the time my daughter turns 70, those $2,000 annual gifts will have grown to more than $30 million! In fact, the account would make her a millionaire by the time she was 40.

Imagine going through life with that kind of safety net.

That's the kind of safety net Social Security should be but isn't, even though most people pay a lot more than $2,000 a year into the system. The way the Social Security program is run in our country, I don't think it's wise for my daughter to count on getting anything back from all the money she will be required to contribute during her lifetime.

The more I thought about it, the more I realized that if there is going to be a safety net for our daughter, it's up to my wife and me to set it up.

Finding a better way

We planned to start by opening an UGMA (Uniform Gifts to Minors Act) account, into which we would deposit $2,000 a year. The advantage of a UGMA account is that the earnings are taxed at the child's tax rate (which should be lower than the parent's), up to a certain amount.

But Dave, our financial adviser, pointed out a downside: When my daughter turned 18, she'd get full control of the account, which could be worth more than $100,000 by then. Visions of my daughter withdrawing the money on her 18th birthday and using it to drop out of school and join a cult flashed through my mind.

Dave suggested we set up a trust instead because it would allow us to specify in great detail the conditions under which our daughter could get the money. If 18 was too young, we could make her wait until she was older. Or we could set some other milestone, such as graduating from college, as the trigger.

Basically, we had to decide at what point 18 or more years in the future we would trust our daughter to handle the money wisely, so that it would really be the safety net we intended rather than a windfall that could fund some sort of wild or self-destructive behavior.

This turned out to be hard to do. I don't think there is any age or milestone that, once attained, guarantees that the child will use the money as we intended. In doing our homework, my wife and I learned of accomplished people who inherited money in their 30s and 40s and nevertheless self-destructed.

Some people never grow up. We don't like to think about it, but there are lots of things our children could do that we would not want to encourage, much less finance.

My wife and I were frustrated when we saw that we couldn't do a good job of forecasting so far into the future. But then we realized we could provide a safety net without picking a point where our daughter would "get the money," and we began to see a solution that works for us.

Simple as riding a bike

We created something we call the Bicycle Trust. Its mission is to assist our children in their efforts to become self-sufficient and valuable members of society. Just as a bicycle enables anyone to travel farther and faster than someone who is on foot, we intend for our trust to amplify our children's own efforts to develop their abilities so they can go farther and faster than they otherwise would have.

A bicycle generally won't take you anywhere unless you pedal. Similarly, we do not intend for the Bicycle Trust to make distributions to any of our children who are not "pedaling" on their own. If for some reason, our daughter doesn't want to develop her talents, we would rather have the money go to help another of our children (or grandchildren) who does.

The trustee of the Bicycle Trust has broad authority to use the assets to best fulfill the mission statement my wife and I wrote for the trust when we established it. In choosing the trustee, we looked for someone whom we could trust to make the decisions in the future that we would make now if we had perfect foresight. Because the trustee will have a lot more information than we have now, we think his decisions will be better than the ones we would make today on our own.

In our, family we've been calling the trustee the "tai-pan" because in the book, "Nobel House," by James Clavell, the tai-pan was the one descendant in each generation who was chosen to manage the family's wealth to advance the family's mission as much as possible.

For estate-planning reasons, neither my wife nor I could be the initial tai-pan, so we chose Dave. When our children are older, our plan is to have one of them become the tai-pan. I think it is unrealistic for us to expect that all of our descendants will turn out great, but I hope that in each generation there will be at least one descendant who would make a good tai-pan. (But just in case the tai-pan gets into mischief, we created the position of trust protector, whose only power is to fire and replace the trustee. My wife and I are the first trust protectors.)

The assets in the Bicycle Trust have not had much time to grow, but I am working hard at it. I hope that by the time my daughter starts her career, the assets will be enough to fully fund her individual retirement account (IRA) every year, pay for her health insurance and perhaps even cover her income taxes.

Start building young

Perhaps this reflects the challenges I've faced and the mistakes I've made in my own life that I hope to spare my daughter. When I was a kid, the maximum contribution you could make to an IRA was $2,000. But since I made only $2,000 working all summer, it was a hard sell to get me to put 100% of it into an IRA. But now I wish I had. Those early contributions that I never made would have made a big difference for me later in life.

When I was younger, I saw even less need for health insurance than for an IRA. After all, health insurance was expensive, and I had never been sick. Now that I'm older, I've seen many people get stuck in jobs they don't like because it's the only way they can get health insurance. My daughter is going to spend a good portion of her life at work. I'd like her to be able to choose a career she loves without regard to the health plan.

As for paying her income taxes, I remember getting my first paycheck and wondering, "Who is Mr. FICA, and why is he taking so much of my money?" It's easy for kids to question the wisdom of working hard when taxes don't leave them much to show for their effort. I hope that having the trust pay my daughter's taxes tips the scales back in favor of working.

These are just some of the examples from our mission statement that I would love for the Bicycle Trust to do for our children someday. Setting up the trust was a lot harder than opening an UGMA account, but it was well worth the effort. I've even recommended Dave to several clients who were having a hard time wrestling with similar issues about their children.

If you like the idea of a Bicycle Trust for your own family, send me an e-mail to:, and I'll pass along the mission statement that my wife and I wrote. I hope that it helps give you a head start on thinking about your priorities for your own family's Bicycle Trust. If you decide to take the next step, I'll even be happy to introduce you to Dave. He's already thought through a lot of the issues for us, so hopefully it won't cost you as much to set up your Bicycle Trust as it cost us.

I don't have a lot of confidence that the Social Security program will be there for my daughter. But if we start planning when our children are young, we can build a better safety net for them than the government had ever dreamed of. That is something I would be proud to leave behind for my family.

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