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Slicing the Inheritance Pie

ASSET RICH, CASH POOR

Let’s say you own a $2 million business, which you intend to pass to your daughter. But, you also have a son who isn’t involved in the business and doesn’t want to be a future part of it. How do you fairly treat family members who aren’t involved with the business when other family successors inherit your company?

ESTATE EQUALIZATION

You could have your heir who won’t be in the business inherit an equal amount of other assets and cash. What, however, do you do if your portfolio is asset-rich but cash-poor? With sufficient time and careful investing, you could sock cash into an account you will use to equalize your estate.

Or, you could buy a life insurance policy with a $2 million death benefit going to your son as beneficiary, while your daughter becomes beneficiary of your company.

Talk to you legal and tax professionals to learn how you might structure an estate equalization approach that works for every family member.

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Avoid the Third Generation “Curse”

Sadly, too often, wealth accumulated by one generation is lost by the third generation because of mismanagement and imprudent spending. Use core values in your estate strategy to help prevent this in your family.

GROUND YOUR ESTATE

First, recognize your core values and how they may differ from those of your beneficiaries. Help them understand that your goal isn’t to impose your values on your beneficiaries but rather to protect family assets as far into the future as possible.

START YOUNG

Educate your heirs throughout their lives. Begin with a basic financial education and bring them into the business as teens so they observe you and learn your business values.

INSTILL VALUES IN YOUR DISCRETIONARY TRUST

Trusts are often created for tax-saving purposes, but other asset-protection purposes must be clear to your trustee, especially with discretionary trusts. Write a letter to inform your trustee of any distribution wishes you have that aren’t dictated in the trust document. Such guidance is especially valuable to a successor trustee administering the trust years after it is funded.

For example, you might prefer the assets be used for higher education, a down payment on a home, or to start a business. Or you might want beneficiaries to receive specific amounts or percentages of the trust assets at certain ages or milestones. Understand that the letter is a guide for the trustee, who won’t be strictly bound to follow the wishes in your letter.

According to Cerulli Associates, a research firm, $54 trillion or more may be inherited by Gen X, Millennials, and Gen Z from their baby boomer parents through 2045. Ultra high-net-worth households, the top 1.5% of households, will account for 42% of this Great Wealth Transfer.

COMMUNICATE YOUR WISHES

Use your letter to convey the details and purposes of your wishes. That way, the trustee will have the flexibility of your intentions to be able to explain why certain distribution requests may be denied.

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Leave Excess Retirement Savings For Grandchildren Without a Big Tax Bill

Naming grandchildren as beneficiaries of traditional IRAs used to be a popular estate-planning strategy. Grandchildren had their lifetimes to empty an inherited IRA, which also let them stretch out income-tax payments on the assets.

NO LONGER

Under 2020 required minimum distribution (RMD) changes, grandchildren must now generally withdraw inherited IRA assets within ten years. That means upping annual required minimum distributions (RMDs) and potential yearly taxes. The tax bill can be particularly onerous if the distributions fall during the grandchild’s (or their parent’s if they’re minors) highest earning years. In addition, inherited IRAs have other complications. The beneficiary can’t convert an inherited traditional IRA to a Roth IRA. Nor can they add money to an inherited IRA or combine it with their own IRA.

According to the Investment Company Institute, Americans held $12.5 trillion in IRAs in 2023, and 52% of households headed by someone 65 or older had one.

OTHER STRATEGIES

Suppose you named a grandchild as a beneficiary of your traditional IRA before 2020. Given the RMD changes requiring a shorter distribution period, you should review your planning and consider whether other transfer strategies might be more beneficial.

IRA Conversions

Look at converting your traditional IRA to a Roth IRA. You can convert over several years to help minimize the annual tax bite. Yes, you’ll essentially be prepaying the income tax. But once the money is in the Roth IRA, it’ll grow tax-free, and the grandchild can take money from the Roth IRA tax-free once they inherit it. Several rules apply, so work with your tax professional.

Trusts

Concerned about how a younger grandchild might use or squander the inherited IRA assets? Then you might consider leaving your IRA to a trust benefiting your grandchild.

A trust allows you to direct your chosen trustee to distribute the money to your grandchild according to the terms you set in the trust document. For instance, you might provide that larger sums of money can be withdrawn only to pay for college expenses or purchase a house.

Trusts can be complicated and may not reduce taxes on the IRA benefits. Before changing your current IRA distribution strategy, consult an adviser well-versed in inherited IRAs.