How to leave an inheritance

In preparing an estate plan, a common issue is how to leave assets to your heirs.

So, what are your options for leaving an inheritance to your children or grandchildren? There are four primary considerations.

Let’s start with a distribution outright to your children, which is the simplest and most common arrangement. With this choice, if your child predeceases you, you could arrange to have their share pass to their children (your grandchildren). Leaving assets outright to children can be a good choice if the children are mature, responsible with money, and are either single or happily married.

Another option is to leave assets in trust for your children. You can arrange the assets in trust to offer the following five benefits:

1. Generally, assets won’t be available to a child’s creditors.
2. Assets cannot be reached in the event of a child’s divorce. (Generally, a divorce court will consider trust assets in tallying what spouses own on divorce, but your assets in trust can be arranged so they are not considered marital property during a divorce settlement.)
3. Assets can pass to your grandchildren when your son or daughter dies. You have the option to include your son-in-law or daughter-in-law as a trust beneficiary when your child dies and still assure that your funds will later pass to your grandchildren.
4. Within limits, assets can avoid estate tax in your child’s estate. This is only critical if your child is likely to have an estate greater than the federal estate tax exemption, which in 2020 is $11.58 million.
5. With proper planning, assets may be arranged to avoid state estate taxes in your child’s estate.

Assets left in trust for the lifetime of your children can be made available to the children in a very generous manner, or you can place strict limits on what can be paid to your children. Here are some of the choices available to you (although your lawyer will want to spell out these terms more specifically in your trust):

• Income may be paid for life.
• Distributions of the trust could provide your child with 5% of the value of the trust each year or $5,000, whichever is greater.
• Principal is to be paid for some additional comforts and luxuries of life at the trustee’s discretion.
• Income and principal are to be paid in the trustee’s discretion for the health, maintenance, education, and support of your child and your grandchildren.

If you are inclined to leave some assets to your children and some in trust, it’s generally preferable to leave retirement plans like Individual Retirement Accounts (IRAs), 401(k)s, and similar accounts directly to your children, and to leave other assets in trust.

However, if you desire to control all monetary distributions to your heirs, you may consider leaving your IRA in trust as well. Talk to a professional to see which option is right for you.

There is one more issue to consider when an IRA or other retirement plan represents a large part of your estate. Let’s say you have three children and have $1 million, two-thirds of which is in an IRA. You want your two oldest children to get their share outright, so you name them beneficiary of your IRA, and leave your youngest child’s share in trust for them.

This plan may work well, but it’s important to understand that the youngest child is getting an advantage with their inheritance. The two oldest children, as IRA beneficiaries, are going to pay income taxes on their inherited IRA as they withdraw funds. The youngest child’s inheritance comes to your trust for them with no income tax. That means the youngest child is getting about 25% more than his or her siblings because no income tax has to be paid on their inheritance.

In this instance, you also need to decide where estate taxes and fees like your last expenses, executor’s fees, and lawyers’ charges are to be paid. If you name different beneficiaries in your IRA and in your trust, there could be some confusion if your will and trust prescribe that last expenses and taxes are to be paid from the trust assets; there could be equal confusion if the IRA beneficiaries need to withdraw funds from your IRA to pay estate taxes. When your child withdraws funds from an IRA to pay estate taxes, he or she has to pay income taxes on the IRA withdrawal.

Consider making all three equal beneficiaries of the trust and all three equal beneficiaries of the IRA for a more equitable arrangement.

Preparing your estate plan is a critical and often involved process. Our Financial Consultants and Private Wealth Advisors are trained to help you build the estate plan that best fits your needs, as well as reach your potential. To learn more, please call 1-800-242-2224, visit us online, or Ask a Citizen at your nearest Citizens branch.