Passing on an inheritance to your children can be a complex planning journey. There are many considerations to take when determining if, how, and when to leave money for your loved ones. From considering family dynamics and parenting values to understanding the financial and tax implications of inheritance planning, it’s essential to examine your decisions carefully.
As you undergo your inheritance planning journey, we’ve included some key considerations you should keep in mind as you navigate inheritance funds. By understanding your options — and taking the time to make informed decisions — you can provide for your children and loved ones in the best way possible.
1. Evaluate Your Financial Wealth
While your instincts may be to take care of your children first, it’s important to make sure that you’ve taken care of your own financial needs so that you can live comfortably after you stop working. After all, in order to take care of those around you, you must first take care of your needs.
Your financial planner can help you create a long-term plan that accounts for inflation over time and includes an estimated savings target for living expenses, income for travel, healthcare, unexpected medical costs, long-term care, and more.
After you have a better idea of your own needs, you can evaluate how much is left to give your children — and potentially grandchildren — an inheritance.
2. Determine When to Give Inheritance Money
One of the most complicated decisions you may make when inheritance planning is deciding when to pass on your inheritance to your loved ones. There are benefits and disadvantages to each timeframe, so take time to determine which route works best for your family dynamics and personal values.
During Your Lifetime
While it’s common for children to be granted access to an inheritance after the passing of a parent, an inheritance can also be given during one’s lifetime. There are several reasons why a parent may want to provide inheritance payments to their children while they’re still living. One reason is that it can provide financial support for their children during their lifetime. The potential drawbacks of passing on an inheritance during the parent’s lifetime includes depleting the parent’s retirement savings and children relying on parents for financial support into adulthood.
Over Time With a Trust
Another route parents may take is to provide inheritance money over time with a trust. An inheritance trust is a popular option that offers a great deal of flexibility with the inheritance funds. Often, parents decide they want to provide wealth to their children after reaching a certain milestone — like completing college, getting married, buying a home, etc. — and that milestone is reached while the parent is still living. Giving an inheritance while still living can allow the parent to see the impact their gift has on their children’s lives and enjoy the fulfillment of providing for them.
Upon Death
It’s very common for an inheritance from parents to be given to their loved ones after death. When parents pass on an inheritance after death, it leaves a lasting legacy for their children, and it gives parents more control over how their assets are used and distributed. This can be important if there are concerns about their children’s financial responsibility or other estate planning tasks that need to be considered.
3. Utilize Wise Wealth Transfer Strategies
Over the next three decades, as Baby Boomers age, up to $70 trillion in wealth will transfer to their heirs, estates, and charities. To make the most of this wealth transfer, it’s crucial to know how to minimize taxes and maximize the value of assets. Simply having wills and trusts isn’t enough to ensure a smooth transfer. You also need to understand how to handle retirement accounts like IRAs, make the most of gifting and estate tax limits, use specialty trusts, and manage insurance and annuity payouts to pass on as much wealth as possible to your beneficiaries rather than giving it all to the IRS. Here are some smart wealth transfer strategies for you to consider alongside a trusted financial advisor.
- Will and Trust: One of the biggest mistakes people make with wealth transfer is dying without a will or trust. Take the time to create a will, trust structures, and powers of attorney documents to ensure your estate is distributed according to your wishes and avoid unnecessary costs and taxes.
- Inherited IRAs: Be mindful of inherited IRA taxes. Spouses and minor children have the most favorable tax treatment, while other beneficiaries have to take the Required Minimum Distribution (RMD) at an amount calculated for their age and gender over ten years. It’s important to select beneficiary designations and complete paperwork correctly to avoid penalties, accelerated distribution requirements, and unnecessary taxes.
- Annual Gifting: Gifting is a smart wealth transfer strategy. The limit every year is $15,000 to each recipient, but that can be doubled to $30,000 when gifted by spouses. Gifting between spouses is unlimited; anyone receiving gifted money doesn’t need to report it on their taxes. However, exceeding the lifetime limit of $11.7 million will result in paying taxes ranging from 18%-40%.
- 529 Plans: Consider using a 529 plan to grow money tax-deferred and distribute it tax-free if spent on qualified educational expenses. Any unused funds can be transferred to benefit a different beneficiary on the plan.
- Cash and Stock Transfers: Be strategic with cash and stock transfers. Any cash or stock transfers below the estate tax threshold must be reported but won’t be subject to tax—but they will eat up the lifetime limit, and anything in excess will then be subject to taxation. Consider making transfers when stock values are low or creating losses that can be used to offset taxes owed.
- Grantor Retained Annuity Trust (GRAT): Consider using a Grantor Retained Annuity Trust (GRAT) to transfer wealth while minimizing or eliminating gift and estate taxes if you’ve reached your gift and estate tax threshold.
- Family Limited Partnerships (FLP): Another smart strategy is to create a Family Limited Partnership. This allows the first generation to manage business interests, assets, or real estate while transferring them to the next generation gradually through gifting within the gift tax limits or estate tax threshold. During economic downturns or lower valuations, gifting interests can be beneficial.
- Insurance: Life insurance can protect and transfer wealth, with lower premiums and more benefits for those who purchase it when they are younger and healthier. Different policy types can build cash value, provide loans, be invested for tax-free growth, or cover critical illnesses and long-term care costs. A tax-free death benefit is paid to beneficiaries.
4. Consider Taxes in Inheritance Planning
While there’s no federal inheritance tax — and only a handful of states have an inheritance tax — there are inherited assets that are eligible for taxation. When stocks, bonds, real estate, and retirement accounts are passed along to heirs, they may be eligible for favorable tax treatment called a step-up in basis. A step-up in basis adjusts the asset’s value when it’s passed on after the parent’s death, reducing the taxes owed by the heir.
5. Make Sure to Consult a Financial Advisor
Inheritance decisions can be complex — and emotional — so consider working with a financial advisor who can assist with inheritance planning. Not only will they be able to provide years of expertise when creating your individualized inheritance plan, but they can help simplify a complex process of navigating financial strategies and tax laws to maximize your inheritance strategy.
With more than $70 trillion transferring from Boomer parents to their heirs, it’s more important than ever to align with a financial advisor about your inheritance plan for your loved ones. Start creating peace of mind today by developing tomorrow’s child inheritance plan. Get in touch with Retirement Genius for more tips on navigating the complex world of retirement.
