One of the biggest worries that parents have is whether or not their kids will be financially ready at age 18 when their childhood savings are to be handed to them.
I can fully appreciate this worry. It seems crazy that an 18 year old can be given (potentially) a lot of money without any training on how to look after it. It’s like your kid turning 17 and saying to them, here’s a car without any driving lessons, good luck! What is likely to happen is that they will make mistakes and wish they’d been trained.
I mentioned in previous blogs a grandparent who transferred their grandson money, on their 18th birthday, as part of their inheritance tax planning. They believed this would help him pay for education, a car or as a deposit towards an apartment. That’s not what happened. The grandson got the money and thought he’d won the lottery. He went and bought a set of gold teeth! You can imagine that the grandparents weren’t best pleased!
In this blog, I go through what parents (or anyone planning on transferring money to a child) can do to help make sure that money will be used in a sensible way which will benefit kids over the long-term.
Blue Tree Money MOT
Let’s use a car analogy for this. For a car in the U.K. (over 3 years old) to be on the road, it needs to have passed a MOT (for those not from the UK, this is a very detailed safety inspection, operated by 'Ministry of Transport', MOT, that has to be done every year to make sure a car is road worthy).
Let’s imagine that before any money is handed over to a soon-to-be-adult, they are required to take a Money MOT. The Money MOT would assess the key areas of risk and what needs to happen before they can receive the money.
How would the Money MOT work?
6 months to 1 year before you plan to transfer money to your soon-to-be-adult children, I would have them answer a series of questions. If any of the answers raise any Warning Indicators, then this is flagged and they are given specific actions which need to be monitored and re-assessed again before the money is transferred.
Below are the 5 questions I would ask and the Warning Indicators I would look out for. I’ve also included the actions I’d like to see them take before money is transferred to them.
I will be doing this with one of my best friend’s sons when he turns 18 as I’m saving £10 per month for him which is invested (I thought this would be a better gift than another toy or book each birthday / Christmas).
[I note these are only examples and are intended to promote the need for them to look after the money they receive. At the same time, I would not overly enforce this if there was strong resistance as ultimately it is their money.]
Part 1 - Saving habits - i.e. make sure they are going to be saving some of the money they receive
Question: Do you have any money in a bank, saving or investment account that you have saved?
Warning Indicator: They haven’t saved any of their own money.
Why? This response is an indicator that they see money only for spending and do not fully appreciate the need for saving money. Those that do not save any of their own money are more likely to spend all the money they receive. For our kids to grow up financially healthy, they need to have a balance of spending AND saving.
Fix: I would explain the difference between Rich and Wealthy to ensure that they see the benefits of looking after their money (being wealthy). I would then want to see some evidence of them actively saving at least 10% of the money they receive over the next few months (the first rule of wealth)
Part 2 - Spending habits - i.e. making sure they aren’t going to spend it all on stupid things
Question: What do you plan to do with this money?
Warning Indicator: They don’t have a plan.
Why? If they don’t have a plan in advance then there is a much greater chance that they spend the money impulsively. This can lead to regret later in life. Whilst I wouldn’t want to control their money decisions, I would want them to have thought about how they are going to use that money. By planning in advance, they will go through a process of considering the different options / opportunities for that money.
Fix: Get them to make a plan for what they will do with the money at least 6 months before. Help them consider the different options available to them. This could include buying a car, using the money towards a deposit on a home when they are older, a combination of a holiday and keeping some in savings / investments.
Part 3 - Standard of living - i.e. making sure they don't start living above their means.
Question: How will this money impact your life?
Warning Indicator: Purchase things, or do things, which are not aligned to their means
Why? When people are given a lump sum of money, they look to buy things which they previously couldn’t afford. A key area for concern is that they don’t consider the longer term implications once the money has gone. For example, they might buy a slightly more expensive car than someone of their means should be buying. Whilst they might be able to afford the car (with the lump sum), they might struggle with the ongoing expenses of a more expensive car (insurance each year, maintenance, tax etc) which could mean they are going to be worse off in the future.
There is also the ‘status’ impact. If you buy a more expensive car, people will believe you have money and therefore you'll feel you have to live up to this status in terms of the clothes you wear, the places you eat and, holidays you go on. These all lead to a material increase in the cost of living which could be above their means and again negatively impact them over the longer-term.
Fix: Help them understand the impacts of living above their means in terms of ongoing costs (The Dragon that Pooped Too Much story helps with this). Get them to make a list of the things they would expect to buy in the future if they weren’t given this money. This will help them consider their current standard of living. The money they are to be given should be to help them buy the things which are aligned to this standard of living or be saved / invested to help increase their ongoing income (and standard of living) over time.
Again, I’m not saying ‘don’t buy this or that’, the idea is to guide them so that the money helps them live a financially healthy life rather than put them in a position which could make them worse off over the long time.
Part 4 - Investing knowledge - i.e. avoiding taking stupid bets
Question: If you are going to invest any of this money, how would you do it?
Warning Indicator: Following a current trend (at the moment this would be crypto)
Why? When we hear of these trends, it is easy to jump on the bandwagon and try to replicate other people's successes. This is especially true when you have no real connection to the money that you are being given, i.e. it’s ‘free money’ so the pain of losing it isn’t as high compared to money you've worked hard to earn.
Fix: Get them to read about ‘The Greater Fool Theory’ so they fully appreciate what is happening with these trends, i.e. they are all based on buying something now and hoping someone (a greater fool) will buy it from you later at a higher price. I would also make sure they understand that the surest way to build wealth is investing in the stock-market, via low-cost index funds, over the long-term.
Part 5 - Debt management - i.e. ensuring they will look after money by avoiding debt, scams and gambling
Question: If they are planning on using this as a down payment “Is this changing how much you borrow?’
Warning Indicator: Yes - I can now borrow more.
Why? A nice lump sum should be a way of reducing the need for debt but could easily end up as a platform for them to take even more debt than they initially planned. Similarly to the question 3 above (standard of living), once the lump sum has been used, the increased ongoing costs from the decisions they make when they feel ‘rich’, when the lump sum reaches their bank account, can have a negative impact on their long term financial health.
Fix: Make sure they understand the implications of the increased cost of debt over the long term. Remind them that most people would love to be debt-free so they can have more freedom. Therefore, get them to consider the opportunity to use the lump-sum as a means to not borrow as much money, rather than as an opportunity to borrow more.
Other parts which could be included in the Money MOT
There could also be other areas to include in this Money MOT, such as their knowledge about Scams, Gambling and appreciating the power of Compound Interest, but I feel the above are the critical areas of focus to make sure any money given will have a positive impact on their future financial health.
Summary
If you are planning on transferring some of your wealth to your children in the future, take the time in advance of giving them this money to ensure that they are prepared and ready. This isn’t just for your own peace of mind that your money isn’t being wasted, it will also massively help them over the long-term (although they might take some convincing about that point).
The best way to make sure your kids pass this Money MOT with flying colours is to help them follow the 3 Rules of Wealth as they grow up.
Thanks for reading!
Will