Creating Huge Wealth With Trust Funds

I’ve been talking a lot about trust funds lately.  I calculated that if someone put $50,000 in a trust fund today, 70 years from now, they could have a dynasty trust paying each of their heirs a $25,000 cash check (in today’s dollars, net of taxes) at Christmas.  There are a lot of assumptions that may not pan out in that figure, but it’s a decent guess.

Maybe I should explain.  On November 19th, 2010, as Aaron and I were in the car driving from my brother and sister’s birthday dinner to meet our friend Ashly at her hotel near the airport, we spent much of the time discussing the concept of trust funds and how compounding is so powerful that even tiny amounts today, left undisturbed for long enough, can grow into dynastic wealth.  There are stories of janitors at colleges leaving $10 or $20 million gifts because they understood how to harness it and people had no idea the wealth they had amassed on their regular paychecks.

The problem, of course, is that I have serious philosophical disagreements with unearned wealth such as that received from trust funds.  When I bought my first car, my first house, my first piano, my first cashmere sweater, my first company, the excitement originated with the understanding that it was my money that I had earned that did it.  Just as Vince Lombardi said, “I firmly believe that any man’s finest hour, the greatest fulfillment of all that he holds dear, is that moment when he has worked his heart out in a good cause and lies exhausted on the field of battle – victorious.”  The reward comes in great part from the effort it took to achieve it.  Nobody gave it to me.  I did it.  There is a sense of healthy pride in that – and gratitude that I was born in a country so rich with opportunities.

I don’t have any kids yet, but if I continue to do what I love, the idea that my grandchildren or great-grandchildren will be able to walk in and pick out $6,000 Brioni suits even if they have accomplished little with their life doesn’t sit well with me.  In fact, it makes me feel somewhat contemptuous.  That capital would have been much better invested in an entrepreneurial studies program or a value investing department at a good college.  I know of one such program that rewards the most promising candidate an actual franchise of a major national food company, giving them a huge head start in life.  That is why I want most all of what I ultimately build to go to targeted charitable causes.

How do I solve this dilemma?  I’ve been working on a solution that I’ve been secretly calling “the Christmas trust” in my internal documents and notebooks.  There is still a lot of work to do, and I’m going to have to bring in the accountants and the lawyers, but I think I can get everything solved and put in place over the next few years.

A Trust Fund Should Generate Enough Money to Help Beneficiaries But Not to Do All the Work of Living

The Trust Fund Objective: Whatever I ultimately do, I want the trust fund to generate enough money for each beneficiary that it will be a help when trying to achieve regular life goals, whether that is buying a house or paying for college, or enough to enjoy spending at a place like Halls Department Store where you could go in and get maybe a dozen new bespoke suits from Armani and Zegna each year.  But, equally as important, it should not be enough to sit around doing nothing.

The Trust Fund Distribution Amount: The figure I finally settled on would be $25,000 in cash (that is after taxes), paid to each eligible beneficiary at Christmas as a gift.  This will be indexed to inflation.  They could use the money for anything they desired.  Those of you familiar with economics will recognize that it is approximately half of the median household income for most of the world’s current advanced civilizations.

Why $25,000?  If you are already employed and doing your own thing as a self-sufficient, responsible adult, a $25,000 Christmas check each year can be a huge blessing.  But it isn’t going to allow you to sit around all day, do nothing, and squander the most precious asset God gave you – time – on the wealth that I generated from my own efforts and foresight.

The Trust Fund Beneficiaries: I would want the trust fund beneficiaries to be anyone who was legally adopted as a minor or biologically sired by me or any of my siblings.  They would not receive distributions until the year in which they turned 30 years old.  The money can only go to those who are gainfully employed, leading productive lives, who are not involved in criminal activity, who can pass a basic financial literacy exam as well as some family history questions to help preserve the cultural heritage that makes us unique.

Why 30 years old?  It leaves a significant enough gap between legal adulthood at 18 and college graduation (if applicable) at 22 so that they can’t rely on the cash to start their life.  They will have to get a job or start a business just as if the money didn’t exist.

Need plays no role in the beneficiary distributions.  To put it bluntly: The trust fund will be written so that under no condition does need influence any distribution decisions.  That means it doesn’t matter if a potential beneficiary is about to be evicted from his or her home, needs a transplant or will die, or is starving to death – this specific trust fund is not their solution; I refuse to sacrifice future generations to their current needs if they can’t manage their own affairs or suffer a run of bad luck.  Instead, there may be other trusts or other inheritances we set aside for those sorts of things.  Furthermore, spouses will be ineligible to receive distributions from these specific trusts.

In other words, I’m interested in creating a nice Christmas gift that can be used to enjoy life more or to accelerate the net worth building process but that still puts the responsibility and outcome in the hands of each beneficiary.

The Mathematics of the Trust Fund

If I go with a 4% of net worth maximum distribution rule, which is what most empirical evidence shows has a high probability of surviving another Great Depression, each beneficiary would require an endowment of $625,000 in net worth sitting in the trust fund. This is easy to calculate; we simply take a $25,000 payout divided by 0.04 to find the result.

If I, and my siblings, have an average of 2.9 children each, which is slightly above average, the first beneficiary generation will mature in a median of 40 years from now.  There will be 11 or 12 beneficiaries.

The second generation will mature 30 years after that, on average, and contain approximately 34 beneficiaries.  The parent generation will still be alive, so the total payout beneficiaries would be approximately 45 or 46 individuals getting Christmas checks from the trust fund.  Going with the higher of the two numbers, that is $1,150,000 in payouts, requiring a $28,750,000 net worth.

The odds are my generation will have died by that time or, at the very least, be very old (approaching 100 years).

The question then becomes: If I want the payouts to start in 2071, how much money must I invest today into the Christmas trust fund to achieve that goal?

Here is where it gets tricky.  If I, personally, as in Joshua Kennon, manage the money as the trustee, I charge no fee for my service, and I put the cash into investments that generate a real after-inflation net return of 9% such as equity in LLC operating companies, real estate, or other assets (which I could do – but that isn’t possible once we went to stock-market-only passive investments that I would demand once the trusteeship moved to an institution so if I died earlier than the odds favor, the trust wouldn’t hit its target), the trust fund would need to be funded with $163,324 and no additional money added ever.  Again, there are several assumptions in that and some situation-specific things I think we could do that make the tax drag and other costs more manageable but that may not be available to everyone.

What If I Wanted the Christmas Trust Fund to Only Cover My Own Descendants?

Of course, if I were only worried about my descendants, and not my nieces or nephews, I’d only need $5,625,000 in the trust fund in 70 years (adjusted for inflation – that would be in today’s money).  I’d only have to invest $32,000 today.

That means that if I were to create a Christmas trust fund and contribute $50,000 to it sometime in the next year, designing it solely for my own descendants, I could practically guarantee that the generation starting with my grandchildren would get a check worth $25,000 in today’s purchasing power each December for the rest of their lives.

Perhaps this is a better way to think of it: I can buy a virtual guarantee, as long as we avoid a revolution or civil war, that my bloodline will always be in the middle class or better.  The cost of this “insurance policy” is $50,000 plus some legal expenses, which are relatively small.  People spend more than that on a car or a Steinway & Sons piano.  The first check to the beneficiaries would be cut in the year 2071.

Someone has to be the first generation.  The question is: Why not you?

Obviously the whole thing is more complicated than this.  You have to adjust for estate tax, work on the terms of the trust funds with a lawyer, etc.  But the point is, it’s not nearly as esoteric as people think it is.

Update: On May 14, 2019, I brought this post out of the private archives as part of a large project to restore some of the historical posts on the blog if I felt they offered academic, educational, and/or entertainment value.  This was one of those older writings that has been requested from time to time.  Reading it now, almost a decade later and on the cusp of becoming a parent, likely within the next 18 months through gestational surrogacy, my feelings on trust distributions have evolved materially.  Through both our personal and professional network, including working closely with the private clients at our global asset management firm, Kennon-Green & Co., I’ve had the pleasure of seeing, first hand, some truly incredible young adults who inherited meaningful wealth and live thoughtful, productive, impressive lives where the money was simply a tool.  It did not spoil them.  It did not ruin their ambition.  It accelerated their efforts akin to what happened with one of my favorite historical case studies, Judge Thomas Mellon, who enabled his sons to go on and amass far more wealth, and far greater political power, as a result of the foundation he gave them.  It is likely that my husband and I will leave far more wealth to our children than we originally planned.  Importantly, by the time they become adults, each of our future sons and daughters will have had a masters-level education in finance, economics, capital allocation, and entrepreneurship so they are capable of handling that wealth.  Still, this piece offers a glimpse into the evolution of that thought process so it is worth restoring if only to show the intellectual and philosophical journey we are taking as our beliefs on the topic evolve.