Important Considerations for Leaving Your Kids an Inheritance

Deciding what to leave to your children – and how to do it – is a challenging topic. But it’s crucially important to explore your options and determine a path that fits with your goals and legacy desires.

Some parents pinch pennies for a lifetime in order to leave a large inheritance, while others spend down their life savings and enjoy their retirement. For those leaving an inheritance, some choose a lump sum and others opt for an income stream.

There is no one-size-fits-all solution. However, one thing that’s easy to agree on is wanting to leave as little of a tax burden as possible on your heirs. Let’s review your options, aspects of the decision-making process you need to consider, and how to reduce your tax burden along the way.

To Leave or Not to Leave

There’s a wide spectrum when it comes to leaving an inheritance, and sometimes tough decisions need to be made. It comes down to choosing how much you want to leave.  You can choose to leave it all, or to leave some to heirs and some to charities, or you can elect not to leave anything. Finding your spot on the inheritance spectrum and meeting personal goals is the first decision in estate planning. It affects each component of a comprehensive and successful estate plan.

Choosing Your Level of Control

There’s a difference between controlling an inheritance and controlling it from the grave.  Some people feel strongly about making this decision. Some want to provide a lump sum to the heirs and allow them to manage the legacy. Others prefer to leave a stream income to their heirs that can help provide a stable income into the future.

In addition to personal preferences and values, there are tax issues to consider. When our clients learn it’s possible to provide their heirs with a tax-free income stream over many years (sometimes for life), they often find it very attractive.

Avoiding Tax Bites

To put this in perspective, consider the parallel between a traditional IRA and a Roth IRA. Choose the traditional route – similar to an IRA or 401K – and the legacy can pass a hefty tax obligation on to heirs. Select the metaphorical Roth IRA route, and the inheritance can pass tax-free. Given the choice, almost everyone chooses to jump on the “leave it tax-free” option if they can.

With current tax rates sitting at historically low levels, paying more taxes today means fewer tax burdens when the estate is divided. It’s a solution that can help heirs avoid scrambling to pay future, unknown potentially higher tax rates in the future.

There are numerous approaches to going tax-free, depending on one’s life and financial circumstances. Learn more about our approach to a tax-free retirement for more insights.

End Inheritance Fights Before They Start

Imagine bringing a family together for the reading of the last will and testament of a loved one in the movies, and you’ll usually see a lot of drama unfold with dissatisfied heirs, unfulfilled promises, and fights about what’s fair, and what’s not fair.

You can avoid will-reading trauma and drama by specifying your wishes in advance in writing. One step that codifies those wishes is the revocable living trust in combination with the will. Another step can be writing a letter to the family explaining what is being accomplished with your legal documents. It helps define your intentions, commitments, and promises clearly and without question.  A letter to your family  can be a fantastic tool.

Managing Expectations

Many parents associate trust funds with “being spoiled” or lazy amid expectations of a hefty inheritance. At the same time, they want to contribute to their heirs’ hopes and dreams for a better life.

Few people share the totality of their financial affairs with family members. Commonly, heirs may not fully understand the size and scope of the future inheritance. This is why one of the most important things to do is clearly communicate your wishes with your family. This communication should be in writing, but it could also be shared during a family reunion or even on a Zoom call. We also encourage you to learn more about common estate planning mistakes as you delve deeper into the process.

Choosing the Legacy

Planning for asset transfer is among the most crucial decisions in the process. For most estates, there are six critical components:

1. Accurate Documents: Ensure all non-trust estate planning documents are complete and current. Older documents should be periodically reviewed and updated as needed.
2. Transfer on Death (TOD) and Payable on Death (POD) Designations: Review and update TOD and POD designations as needed so that bank and brokerage accounts are liquid and accessible.
3. Asset Titles: Real estate, cars or collections must have titles properly written to ensure smooth transfers to the proper heir.
4. List of Personal Belongings: Spell out in writing who gets what possessions after a death. Define who receives jewelry, precious metals, furniture, firearms, wedding rings, and artwork. These are just a few examples.
5. Retirement Account Beneficiaries: Check the account information to ensure beneficiaries are current and properly listed. Review older IRA, 401K or other retirement accounts, ensuring they list current heirs as beneficiaries and not former spouses from when the accounts were started.
6. Net Worth Statement: It’s helpful in the estate distribution to have a recent net worth statement for the family to fully understand the financial picture at the time of death.

Other Inheritance Decisions to Make

Choosing a living inheritance

Planning for financial lives after death is one part of the inheritance process. The other is planning for retirement income to maintain life quality after regular paychecks stop. This step helps ensure enough money for life. In this podcast, we explain the concept of “tax-free” when it comes to retirement income.

Choosing to treat children fairly.

Treating heirs fairly does not always mean dividing equal portions. Dividing the money is a choice based on individual circumstances. Perhaps one child has married into money and will never be wanting; another might have unique financial circumstances. The money can be divided to meet individual family needs. That division does not say that one child is loved more than another.

Choosing to be transparent

Being transparent and communicating wishes clearly and in writing makes it harder for children to argue that they were promised something different. It spells out the family legacy.

Passing the Torch

Working out the challenges while healthy and cognitive is just a part of the estate planning process. With the heavy emotions and many decisions influenced by finances, taxes, and legal requirements, steps can be most effective when taken in concert with professional counsel.

Request a call or send us a message to see how our financial planning and estate planning professionals in Scottsdale and Prescott can help you on this journey.

This material is intended for informational/educational purposes only and should not be construed as specific tax, legal or investment advice. Individual circumstances may vary.

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Fixed insurance products and services are separate from and not offered through Commonwealth. Tax preparation and accounting services offered by Hosler Wealth Management, LLC are separate and unrelated to Commonwealth. Commonwealth Financial Network® does not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation.

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