On a recent family trip, I found myself in an airplane, sitting next to my 2-year-old while holding my 10-month-old on my lap. Fortunately, it was a short flight. Before we took off, the flight attendant delivered the familiar message, “In case of an emergency, put on your own oxygen mask before assisting your children.” We’ve all heard this advice countless times, and it’s easy to overlook its importance. But the same principle applies when deciding whether to give your kids their inheritance now or after you’re gone. Just like the flight attendant’s advice, my suggestion is to ensure your own financial security first. Ask yourself if you have enough money to comfortably provide for your children or anyone else.
One significant variable in this financial planning equation is the potential cost of long-term care as you age. Most certified financial planners can help you calculate this using specialized software or tools. Assuming you’ve addressed this aspect and have sufficient funds, it’s essential to consider the impact on your children when deciding how to manage your assets.
Is It Beneficial to Give an Inheritance Early?
The impact of giving an inheritance early can vary widely depending on how much money is involved and who the recipient is. Think about your kids’ past behavior when they received a significant sum of money. Did they use it responsibly to cover their expenses, invest it wisely, or perhaps spend it on luxury items like a fancy car? If your money ended up going towards something extravagant, it might be worth reconsidering.
But in all seriousness, the person receiving the funds often matters more than the amount or how it’s spent. This is one of the reasons why revocable trusts are a popular tool in estate planning. They give you the ability to dictate how and when the beneficiary gets access to their newfound wealth.
Think About Your Kids’ Ages When Giving Gifts
Imagine you’re 65 years old, and you became a parent to twins when you were 30. Statistically, you may live until about 85. So, you’re faced with a choice: should you provide financial support to your kids over the next 20 years, or wait for two decades? In 20 years, your Millennial children will be around 55 years old, likely earning their highest incomes and possibly sending their own kids to college. This is a phase when their income may significantly exceed their expenses, meaning they might not urgently need the money at that point.
On the flip side, the period when your children are young, possibly with substantial childcare expenses and perhaps one spouse staying home to care for them, could be when they face the greatest financial strain. During this time, their expenses might surpass their income, making it a crucial period of financial need.
What About Tax Considerations?
Now, let’s talk about taxes. While this period might be when your kids need financial help the most, it might not be the best time for tax reasons. Thanks to a significant gift tax exemption, you usually don’t need to worry about gift tax unless your estate is worth more than around $12 million. However, it’s essential to think about capital gains and income taxes.
In some cases, we suggest giving stocks to your kids while they’re in school and have minimal income. Why? There’s a tax advantage here. If you sell the stock, you could be looking at a 15% capital gains tax. But if someone in the lowest two income tax brackets sells the same stock, there’s no tax to pay.
Now, here’s the catch. If you leave stocks as part of your estate when you pass away, there’s something called a “step-up” in basis. This means your child won’t have to pay any taxes on the gains the stocks made during your lifetime. So, if you were fortunate (or savvy) enough to buy Apple stock back in the ’90s, it’s often best to leave those assets as part of your estate.
This step-up in basis applies to all kinds of valuable assets, including real estate. It can be a smart way to avoid hefty tax bills on investment properties and your primary residence.
So, first, make sure you have the financial capacity to give. Then, have a serious conversation about the impact of your decision. Finally, create an efficient plan to carry out your wishes.
