As the saying goes, nothing is certain but death and taxes. And since you can't take it with you, what will happen to your assets once you're gone? Estimates say up to $30 trillion will be left to heirs over the next 30-40 years, according to Accenture, a consulting firm. Everyone has a different situation and every wealth transfer unique- so there is no one size fits all solution.
So how do you pass your wealth on to your heirs? Generally, there are 4 ways to pass on wealth:
1) Annual Gift - You are allowed to give up to $14,000 each year (or $28,000 as a married couple) to as many individuals (heirs, relatives, friends, strangers...etc) with no tax implications for both the giver and the receiver of the gift. If you have 5 grandchildren, you can give $14,000 to each of them, so $70,000 in total per year, each year.
Stock or other investment securities can also be gifted- they can be an even more effective way to transfer assets than cash. If stock is gifted, the heirs can either keep or sell the stock. However, one commonly overlooked tax benefit to minimize taxes is referred to as the step up in basis. When your heirs inherit the asset (securities, homes, etc) the cost basis of the asset is “stepped up to value” on the date of death. These are only assets held solely by the deceased. Joint owned assets are subject to a half step up in basis. Also, it does not apply to IRAs and other tax deferred accounts.
This is an extremely effective method of distribution. However, it does contain several caveats: for one, the assets are theirs once they receive them. So if the kids or grandkids are young, you would have no power to dictate how they use the funds. This can be mitigated using an UGMA/ UTMA account. These accounts allow for custodial control until the age of 18 or 21. Second, you do not know how long you will live and therefore how much assets you need to hold back. You can produce a situation where you outlive your assets or conversely, die after only one or two years of distributing the funds leaving a large balance left to be distributed at death.
2) Designating a Beneficiary - Although only available for certain assets and accounts, it is by far the easiest method of allocating your wealth. Generally it is available for IRA and employer-based qualified accounts, as well as things like life insurance and annuities. Whenever you have set up a new IRA in Fidelity for example, or a new 401k at work, one of the first questions the account setup will ask is who are the beneficiaries of the account. This can be multiple people with complicated allocations between them, and can be changed at any time.
3) Joint Ownership - This is exactly what it means. If two people own a home, a car, or a joint bank or investment account, when one of the owners dies the account simply passes in total to the other joint owner. It can't get any quicker or easier than this. Not every type of assets can have joint ownership, but your biggest and most common assets generally can be owned jointly- again think homes, cars, boats, and bank or investment accounts.
Remember, both names listed as joint owners have the same rights and authority.
4) Will - They can be versatile tools to specify exactly how you want your assets distributed after you're gone, especially those without a beneficiary designation or joint ownership. Simple wills work best when all heirs get along, when the heirs are already nearing or at adulthood, and the details of how assets will distributed were conveyed and understood ahead of time. However, unlike the first two methods, a will involves probate and an executor- the person in charge of distributing the assets and paying off any taxes and fees, and probate court.
Wills are divided between living will and last will and testament. The difference being the former goes into effect at signing, the latter at death. Both can be modified up until death as long as you are mentally sound.
When assets pass through a will, expect that 5-10% of the value of the assets will be used to pay legal and probate fees. Wills pass through probate meaning a court oversees the administration of the will and properly distributes the assets according to the deceased's wishes. This can significantly slow the process of distributing the assets.
5) Trust - This is the most versatile method for wealth transfer. Trusts not only detail who will receive what assets, but also when and how. They can minimize estate taxes, protect your estate from the mistakes of your heirs and/or maintain privacy by avoiding probate. The cost to set one up generally ranges from around $2,000 to over $10,000, depending on complexity, with additional costs for individual tweaks and maybe even up to 1% of assets to administer it (depending on its size).
Trusts are best for more complicated family situations, such as when the heirs are young and you want to avoid having them receive a lump sum of cash, or you want certain life goals met (such as marriage or a degree). It is the best method to attach "strings" to certain gifts.
Wills vs Trusts
One main difference between a will and a trust is that a will goes into effect only after you die, while a trust takes effect as soon as its signed. A will is a document that directs who will receive your property at your death and it appoints a legal representative to carry out your wishes as opposed to a trust that can be used to begin distributing property before death, at death or at specified times afterwards.
Other differences include:
A will only applies to solely owned assets at the time of death (not anything in joint ownership accounts or assets in a trust)
A trust only applies to assets that were specifically named and transferred to the trust
A will goes through probate- a trust does not
A will can designate guardians for minors, arrange for the funeral, and leave final wishes
A will is a matter of public record while a trust remains private
A trust provides for situations such as mental illness and incapacitation- a will does not since it only takes effect at the time of death
The quick takeaway here is that a trust gives much more versatility in regards to protecting the assets as well as the heirs from many pitfalls that occur from inheritances.
If you have concerns over whether or not one or all of your heirs could be reckless with their inheritance, you can use a trust with a phased distribution schedule that you have defined and documented. Trust attorneys recommend this method of giving. This would allow you to distribute assets in multiple phases based on age or other circumstances.
Estate (or Death) Tax
As we stated in the intro, the only certainties in life are death and taxes. With the estate tax, this can occur simultaneously. The Estate tax is an inheritance tax for couples' estates over $10.68 million and for individual estates over $5.34 million. Over those limits, all assets will be taxed at 40%.
A Traditional IRA becomes an Inherited IRA after death and simply put assets will be taxed as ordinary income at withdrawal. There is more to it than that which we won't get into here- however this article goes into much more detail.
Another strategy is to convert a Traditional IRA to a Roth IRA (see our article here). A Roth does not have required minimum distributions (RMDs) during your lifetime. If you leave your Roth IRA to your spouse, they can basically treat it as their own and won’t be required to take distributions or have to pay taxes. However, you must meet the general distribution obligations in order to withdraw from the account- in other words be 59 1/2 years of age, the account must be open at least 5 years...etc.
If you are not the spouse of the deceased account Roth IRA owner, you have two options: Take a tax free lump sum or roll the assets into an Inherited Roth IRA. This account acts similar to a regular Roth, it grows tax free and withdrawals are also tax free. However, the limitation here is time. You have until Dec. 31 of the year after the year in which the owner died to begin taking required minimum distributions (RMD) annually. If you don't make the RMD by that deadline, you will need to have withdrawn all the assets by the end of the fifth year after the year of death. The RMD you will be subject to is based upon the IRS's single life expectancy table.
The choice between leaving a Traditional IRA vs a Roth IRA to your heirs is a much more complicated one. So do you convert prior to your death or not? Short answer is that if you heirs (presumably your children or grandchildren) are in a lower tax bracket than the IRA owner, then a Traditional IRA is better to bequeath. If the reverse is the case, then a Roth IRA is better. However, some situations are more complicated and we suggest you consult a tax expert. This article articulates the choice well...
Making it Last...
According to Kiplingers, family assets do not last beyond one generation 70% of the time. At two generations, 90% of the time the assets run out. Planning and education are crucial to making sure heirs don't have an overwhelming sense of entitlement or are reckless with the assets. Demotivation can destroy their career drive or ambitions.
There are several steps experts recommend to ensure the funds last:
1) Discuss wealth with your kids- money should not be hidden or taboo to talk about. Communication about the family situation is key.
2) Teach them to value money- its best your heirs are smart with money, know about investing, budgeting, and spend wisely.
3) Delay wealth transfer- studies show the later in life your children receive their inheritance, the lower the chances it will kill their motivation and career. As we discussed earlier, a trust is the best strategy to accommodate this.
Every family and situation is different- so there is not one universal strategy for all. But with some education and a bit of planning, you can ensure your heirs live what most parents want for their children: a better life than they had.