The Psychology of Gifting to Less Financially Responsible Heirs

“Shirtsleeves to shirtsleeves in three generations.”

This well-known adage, supported by research from the Williams Group, reveals a harsh truth: 70% of inherited wealth is lost by the second generation and 90% by the third. Even in high-net-worth families, financial discipline rarely transfers as easily as money itself.

For those with heirs who struggle with financial responsibility, simply leaving them a lump sum can be a recipe for rapid depletion or the enabling of poor decisions. Those who are most responsible may be subject to creditors, where asset protection planning can be prudent, such as in high-risk professions like being a doctor or simply being married. The challenge isn’t just about the money—it’s about the psychological biases that affect decision-making.

In this article, we’ll explore three key behavioral finance concepts that contribute to poor financial stewardship or third-party actions over which individuals have no control and how a well-structured estate plan can help mitigate these issues.

Psychological Trap #1: Projection Bias – Why We Overestimate Others’ Financial Discipline

Projection bias leads us to assume that others share our beliefs, values, preferences, and decision-making tendencies. If you’ve spent decades making careful financial choices, it can be easy to believe your heirs will do the same. Unfortunately, this assumption often leads to ineffective estate planning, where heirs are given unrestricted access to wealth they aren’t equipped to handle or put at risk for others trying to go after it.

How to Plan Around Projection Bias

• Protected Trusts: Instead of distributing your assets outright to an heir, consider keeping the funds “in trust” for their benefit, where they receive the income and can only invade the principal for health, education, maintenance, and a standard of living. As a result of this structure, the assets in these trusts are generally unavailable to their creditors, including those in the event of divorce.
• Structured Trusts: Instead of direct inheritance, consider an incentive trust that releases funds only when heirs meet specific financial or personal milestones (e.g., maintaining a job, earning a degree, etc.). This can be especially prudent when considering generational trusts, particularly when the grandchildren are young or have not yet been born.
• Financial Education: Establishing a relationship with a financial advisor who understands family governance planning and can help educate heirs on wealth preservation before they receive an inheritance.

Psychological Trap #2: Prudence Bias – Why We Overcorrect and Stifle Growth

Prudence bias occurs when individuals overemphasize caution in decision-making. While this might sound beneficial, it can lead to excessive restrictions that hinder an heir’s ability to develop financial independence. For example, an estate plan that is too rigid may create resentment or dependency, discouraging heirs from learning to manage money effectively or attempting to circumvent the plan (even to their own detriment).

How to Disrupt Prudence Bias and Balance Control with Autonomy

• Discretionary Trusts: Appointing a trustee (a family member or a professional such as a corporate trustee) who can make case-by-case decisions allows for flexibility while maintaining oversight.
• Gradual Wealth Transfer: Instead of a large windfall, staggered distributions—such as a “trial” portion at 25, another at 35, and the remainder at 45—encourage heirs to gain experience managing smaller sums before receiving full access.
• Gradual Control: Where asset protection is desired, one may consider a third-party trustee until a certain age when the heir becomes a co-trustee and then eventually takes over as the sole trustee while keeping the funds “in trust.”

Psychological Trap #3: The House Money Effect (Chosen Bias) – Why Inherited Wealth Feels Different Than Earned Wealth

The “house money effect” refers to the tendency for individuals to treat unexpected gains, such as an inheritance, more frivolously than the money they have earned. Many heirs view an inheritance as bonus money, leading to riskier investments, overspending, or poor financial decisions.

Based on our experience with thousands of families, we have found that existing spending behaviors are often difficult to change. For example, “spenders” don’t become financially responsible with more money. It usually gets worse.  On the opposite side of the spectrum, “savers” tend to value the safety and security that money provides, and they typically funnel their wealth to the next generation, making estate tax planning a higher priority.

How to Beat the Chosen Bias and Create Guardrails Against Overspending

• Spending Rules: Consider setting up a spendthrift trust, which limits how much an heir can withdraw per year, reducing the likelihood of rapid depletion.
• Trustee Oversight: A corporate trustee or family fiduciary can ensure funds are allocated responsibly while still providing access for essential expenses.

How a Financial Advisor Can Help Navigate Spending Behaviors

Navigating the psychological challenges of wealth transfer requires a structured and informed approach. A financial advisor can:

• Conduct family meetings to introduce responsible financial habits before wealth is transferred.
• Assist in structuring an estate plan that best suits the goals of the parents and well as navigating family dynamics. Examples include setting up and managing trusts, implementing staggered distributions, and creating financial education plans tailored to each heir’s specific needs.
• Provide ongoing coaching and accountability to inheritors, ensuring they have a trusted guide to help them make informed financial decisions.

By understanding and planning around behavioral biases, you can help ensure that your legacy lasts—not just for one generation but for many to come.

Behavioral Finance Planning and Coaching at Mission Wealth

Wealth transfer is more than a financial transaction; it’s a behavioral challenge. Assuming heirs will manage money as you would (Projection Bias), being overly rigid to protect it (Prudence Bias), or underestimating the impact of “free” money (House Money Effect) can all lead to unintended consequences.

Thoughtful estate planning, combined with financial education, asset protection, tax planning, and structured oversight, can help heirs build and sustain their wealth rather than squander it.

If you’re interested in ensuring your wealth serves your family for generations, consulting a financial advisor at Mission Wealth is one of the most effective steps you can take.