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tax matters

This week has been something of a family reunion for my wife's side of the family. Our niece is getting married, so the family is all together. Given that we're all here, my mother-in-law has asked my wife and her four siblings to take yellow sticky notes and put them on the various pieces of furniture, artwork and other items that they would like to inherit one day. I grabbed the sticky notes from my wife and immediately put her name on the Elvis clock in the basement and the toilet bowl mug in the cupboard.

Have you decided what you're going to leave behind for your kids? Sure, the list might include specific items, but might also include financial assets such as stocks, bonds, cash, real estate and more. As part of any good estate plan, you'll have to decide: How much is enough for the kids?

The options

At the highest level, you can do one of three things with your money: (1) spend it during your lifetime, (2) leave it to future generations, or (3) give it away. Think of these as three types of capital: Financial independence capital, legacy capital and social capital, respectively. When we talk about how much you're going to leave the kids, we're talking about legacy capital.

When I ask parents how much legacy capital they intend to leave the kids, the answer is often the same. Most people assume that the kids should inherit everything parents have left over at the time of death. And there's nothing necessarily wrong with this answer, especially if the size of the estate is not significant enough to be life-changing for the kids.

But the answer as to how much is enough as an inheritance should be given careful thought. Warren Buffett once said that parents should leave children "enough money so that they would feel they could do anything, but not so much that they could do nothing." There's a framework that I think makes sense when deciding how much to leave the kids.

The framework

Consider breaking down the inheritance you leave your kids into four components: (1) specific assets or items you'd like each child to have, (2) an amount to cover specific costs (such as education of grandchildren, paying off debt, or contributing toward a home), (3) an amount for emergencies, and (4) an amount to provide a supplement to their income.

Take an example. Suppose that Peter has four children: Tori, Lincoln, Virginia, and Lewis. He wants to leave each child with $50,000 to help pay down debts they have, $100,000 to contribute to education costs for grandkids, $50,000 for emergencies and he wants to supplement each child's income to the tune of $30,000 annually.

In order to provide $30,000 of pre-tax income to each child annually, he's decided to leave a pool of capital amounting to $500,000 to each, assuming a 6-per-cent return on that money annually ($500,000 times 6 per cent equals $30,000).

So, if you add it all up, Peter plans to leave each child $700,000 ($50,000 for debts plus $100,000 for education plus $50,000 for emergencies plus $500,000 to supplement income). Since he has four children, the total inheritances being left behind will be $2.8-million ($700,000 times four kids). Peter's total estate is worth $8-million today. What will he do with the rest? Don't forget, there are two other things you can do with your money: Spend it during your lifetime (financial independence capital) or give it away, perhaps to charity (social capital).

In addition to the financial assets each child will inherit, Peter is leaving specific assets to specific kids: The piano is going to Tori, the 1957 Corvette to Lincoln, his wife's jewellery to Virginia, and his hockey card collection to Lewis.

The nuances

Before you figure out how much you will leave to each of the kids, be sure to calculate how much you'll need as your financial independence capital. After all, you may not have much left to give to the kids if you're going to spend it all in your lifetime. Think also about how much you intend to give to charity – your social capital. If philanthropy is a key priority for you, this might affect what's left over as legacy capital for the kids. A trusted financial adviser can help with the math here.

Finally, you may need to revise your will once you've decided how much is enough for the kids. Visit a lawyer to talk over revisions to your will, and don't forget to revise your will periodically.

Tim Cestnick is managing director of Advanced Wealth Planning, Scotiabank Global Wealth Management, and founder of WaterStreet Family Offices.