Deciding to Provide for Heirs Can Impact Many Financial Decisions
Regardless of the industry you’re in or the type of career you have, there is one thing that rings true for most people: the ability to leave an inheritance behind for your loved ones feels like the ultimate measure of success. As you’re toiling through years of hard work and financial sacrifice, it is gratifying to know that your strategic efforts will culminate in a financial legacy for your children that can provide security and peace of mind.
While there is much emotion tied up in the decision to provide an inheritance for your children, you’ll want to be sure you go about it in the right way. This single decision can impact all of your financial decisions, including how much you put into savings, the types of retirement plans you utilize, and how or when you take distributions.
In order to ensure you properly cover all your financial bases, here are eight considerations for passing an inheritance to your children.
1. Your Personal Income Needs
Keep in mind that one of the greatest gifts you can give your children is to be self-sufficient in retirement. To that end, don’t make the mistake of giving away more of your retirement savings than you’re truly able to. Too many families spend their life savings on their children’s education, for example, rather than protecting their own retirement needs. While the decision to provide for your children can be a very emotional one, it’s important to be financially savvy about it, too. Assess how much you’ll need to spend on yourself, then develop a savings and withdrawal plan. Don’t forget to take inflation into account, and to maintain a diversified portfolio that can help you keep pace with it over time. If you’d like professional guidance, we have expertise and software designed to help you properly assess your retirement needs.
2. The Rising Cost of Healthcare
One of the biggest concerns for retirees is an unexpected illness and ensuing medical bills. In fact, a recent study showed that people spend an average of $122,000 on medical bills between age 70 and the time of their death, mostly paid out-of-pocket. It can be complex allowing for this in your financial plan, but it is important to do so. It’s also risky to rely on government programs like Medicare and Medicaid because they simply won’t cover everything. For example, Medicare does not cover the costs of an assisted living facility, where costs can mount quickly and torpedo an intended inheritance. For some, long-term care insurance can provide useful asset protection, though such policies can be costly and should be reviewed carefully before purchasing.
3. Outliving Your Money
As average life expectancies rise, many retirees will be at risk of using up their nest eggs. Make sure you have a plan to manage your savings and withdrawals appropriately so you can avoid depleting your assets while you’re still alive. After all, if your goal is to leave your children an inheritance, the last thing you want is for them to end up paying some or all of your bills. If this is a concern for you, consider buying an immediate annuity, which would provide you with a guaranteed amount for as long as you live. When done correctly and with the right financial plan, retirement researcher Wade Pfau, Ph.D. argues this may provide an optimal, risk efficient outcome.
4. Taxes
While there is no fool-proof way to protect your heirs from taxes, there are choices you can make that will allow them to enjoy more favorable tax treatment. For example, inherited stocks and mutual funds are eligible for a step-up in basis[1] that could lead to significant savings.
You should also be mindful of the rules for inheriting IRAs, such as the requirement that non-spousal beneficiaries take full distribution of the amount inherited within ten years. Formerly, heirs could take advantage of a “stretch IRA” that allowed them to stretch distributions over their entire lives, but this tactic was eliminated by the Setting Every Community Up for Retirement Enhancement (SECURE) Act in 2019. (Exceptions remain for a child who has not reached the age of majority, those who are disabled or chronically ill and heirs who are less than ten years younger than the IRA owner.)
Some retirement accounts, such as IRAs and 401(k) plans, defer taxes on capital gains, interest and dividends until the funds are withdrawn. Then, it is taxed as ordinary income. If you believe you will be in a higher tax bracket in retirement than you are in currently, you may consider a Roth IRA or Roth 401(k), where earnings grow tax-free, and there won’t be any taxes upon withdrawal either. There are income limitations for contributing to a Roth IRA, but there are no such limitations on a Roth 401(k). Speak to your tax professional or financial advisor before taking action.
5. Benefits of a Trust
A trust may be essential in states such as California where there is expensive and time-consuming probate for anyone whose estate has assets worth more than $100k. It is also valuable if you wish to control distributions, for instance, to ensure that specific assets pass to designated children. Trusts can also be particularly helpful when you or your spouse have children from other relationships or when you don’t have a prenuptial agreement in place
6. Wise Investing
This is always good advice, of course, but choosing your investments wisely when you hope to pass inherited assets to your heirs means designing a portfolio that will last over several generations. You need a portfolio that will continue to grow, preserve capital, and generate income. You might consider growth and income equities or laddered bonds. Previous generations tried to avoid dipping into the principal for withdrawals. However, this strategy has not worked quite so well in recent years, as income has declined and growth stocks, which do not tend to pay income, have outperformed.
When you’re estimating the amount that you’ll be able to leave to your children through investment assets, be sure to consider both inflation and compounded growth.
7. The Mechanics of Your Legacy
You have several options available to you for passing funds to your loved ones and leaving a meaningful legacy for them:
Avoiding Gift and Estate Tax
The good news is that very few people in the United States will owe gift and estate taxes under current law. In 2020, a couple may gift or leave $23.16 million combined to their heirs. Of course, this estate tax exemption could be dramatically lowered in the future. However, if a couple gifts this amount today they will pay no tax, as long as they file a gift tax return. This provides a lot of opportunities for planning the transfer of your assets in a tax-efficient way. Everyone can also make multiple annual gifts of up to $15,000 per gift without paying tax or having to file a gift return. However, note gifted assets lose the step-up-in-basis on death, so for most people, it is not a good strategy to gift assets other than cash.
Life Insurance
Term life insurance is generally affordable and essential for adults who have dependents. The proceeds are income-tax-free and will support the policy holder’s family and pay off a mortgage should they die prematurely. It only stays in place for a limited “term” such as 25 years. There is also “permanent” insurance, which is designed to be kept in place “permanently” and, thus, will pay out on death at any age. These policies can be expensive and treacherous but, whilst not relevant for most people, they can be particularly useful for a family who has significant business or real estate interests worth more than the estate tax exemption resulting in a large tax liability on death. Such a policy can help the family avoid liquidating assets to pay estate tax liabilities.
8. Legal Details
As you develop the specifics of your estate plan, it will be important to seek out professional guidance. Before taking action, consult an estate attorney, tax attorney, or a financial planner who specializes in estate planning for strategic guidance. These professionals can also ensure you have everything properly preserved in writing.
On Working With a Financial Planner
If you’re unsure whether your financial plan maximizes your ability to provide an inheritance for your children while also protecting your retirement, seek out the guidance of a financial planner. At WellAcre, we offer customized, comprehensive financial planning and decades of experience you can rely on. If you’re ready to start a conversation about your financial future and the legacy you wish to leave to your children, contact us to start a conversation today.
