Families with a tremendous amount of wealth worked extremely hard over a lifetime to earn it, and they typically have 3 main concerns when transferring that wealth:
- Unsure of whether they should gift to their children before their death
- Having the next generation spend through their wealth after death
- Giving their wealth to the government after death through the estate tax
The media is putting a tremendous amount of pressure on this idea of “The Great Wealth Transfer.” Although important, it does not have to be as intimidating or complicated as it sounds. This article will give you straightforward solutions to consider to put the above 3 concerns to rest.
Main Takeaways
- You can help to mitigate your estate tax through simple gifting strategies over long periods of time.
- You can protect your wealth from spendthrifts after death by documenting your wishes through careful estate planning.
- You can help your children in a variety of ways and efficiently transfer your wealth today without impacting your estate tax exemption.
- Decisions around wealth transfer need to consider factors beyond the financial ones.
What Are Your Giving Options for Generational Planning?
Method One: Giving to Your Children/Grandchildren Before You Pass
Children and grandchildren could certainly use your help financially no matter what stage of life they are at. Grandchildren entering college are usually in need of assistance with their tuition. Children in their late 20s and early 30s are typically getting their financial footing living independently and could use a cash infusion to buy a house.
Finally, children who become parents in their 40s may find themselves stretched financially as they try to afford daycare, family vacations, and a bigger home for their bigger family.
Although this may sound attractive, it is not always a fit for every family. You may want to think about the below pros and cons before you start transferring your wealth now.
Pros
- Anecdotally, my clients who have given money to their children while they were alive told me it meant a lot to them to be able to watch them enjoy their wealth for important life events.
- Transferring money to your children now lowers your taxable estate and may save you estate taxes down the line.
- You can see how your children interact with inherited wealth and be able to give them guidance on how to use it as you gift it.
Cons
- Certain children may develop a dependency issue and will turn to you for any financial problem they encounter.
- Your children may get the impression that they will be inheriting substantial wealth. This can lead to children lowering their career goals or ambitions.
Method Two: Giving to Your Children / Grandchildren After You Pass
Many families are comfortable with holding onto their wealth until they pass away. At the end of the day, they feel that they are the ones who earned that wealth in the first place and so there is no need to share that wealth until they no longer need it themselves.
After all, some inheritance is better than no inheritance regardless of when their beneficiaries receive it. However, just like the above, there are financial and family considerations you should think about before you decide.
Pros
- You are encouraging your children to be financially independent. This may teach them valuable life lessons along the way.
- Putting assets into a trust for distribution after your death can help ensure that your wealth is not spent quickly because you can control how and when it is distributed.
- Retaining your wealth allows you to enjoy your own life experiences and expenses without having to overextend yourself to help your family in retirement.
Cons
- If you do not properly prepare your estate plan, retaining more assets in your taxable estate increases the chances that you will owe estate taxes after you pass away.
- Children are more likely to need your help financially when they are younger and you are still living. They may be financially stable by the time you pass away and they may resent that they didn’t receive help when they needed it.
Three Wealth Transfer Strategies for Gifting During Your Lifetime
1. Gifting Up to the Annual Limit Each Year
For families who want to gift to their children, advisors will normally recommend that they start by gifting up to the annual gifting limit. This allows them to gift without lowering their estate tax exemption. Wealthy families normally think that this is a drop in the bucket of their estate. However, they often forget:
- Your spouse can also gift up to the annual gifting limit to your child.
- You and your spouse can also give to your child’s spouse each year.
- You can make gifts in both December and January to make a larger gift in a short period of time but spread it across two tax years.
- You and your spouse can gift money into a 529 for the benefit of your child’s child.
Real Life Example
I had a discussion with a client about this back in 2022. He wanted to surprise his 4 children with a very generous Christmas gift of $50k/child and he was very excited to present them with a check from him. However, this individual was also someone who would owe estate tax after he passed and so every dollar above the gifting limit was going to end up costing his family in the long-term.
By simply suggesting that he and his wife write 4 checks instead of 1 (2 before Christmas and 2 in January), he was able to split the gift over 2 tax years and both give his children a great surprise and ensure that they give less to the government when he passed.
2. Paying Directly for Medical and Tuition Expenses
Whether it’s for a sports car or a hospital stay, parents assume that all gifts are made equal. However, that is not the case. Payments that are made directly for medical expenses or tuition are exempt from the gifting limits and can be a great way for parents to get money out of their estate and help their children with extremely important expenses.
I always tell parents that the best gift you can give your children is to pay for their children’s schooling. With how expensive medical stays and college costs are, even families with millions above the exemption limit can find that this is a worthwhile way to whittle away at their estate.
Warning: The biggest mistake people make here is that they will give the money to their children and tell the children to pay the medical or tuition bills themselves. This defeats the whole purpose of the exclusion. You have to make the gift directly to the medical or educational organization.
3. Intra-Family Loans
One issue families run into can be when their child needs their help with a large purchase, such as a home. Even if they gift-split with their spouse, gift over 2 tax years, and gift to their child’s spouse they may not come close to the total amount needed for a down payment.
This is where an intra-family loan can be a great tool in the tool box. This is a loan agreement between parents and a child where the child can receive a cash infusion and the parents can keep their estate tax exemption intact. I always suggest consulting an attorney to properly draft the loan document.
Pro Tip: If the loan is structured properly, you may be able to forgive loan repayments for principal and interest up to the annual exclusion each year. This may allow you to give multiple year’s worth of annual gifts up front without dipping into your exclusion while also keeping more money in your child’s pocket through the forgiveness of loan payments.
Two Strategies for Transferring Wealth After Your Lifetime
1. Using Irrevocable Trusts for Estate Planning
Irrevocable trusts are commonly used in estate planning for ultra-wealthy families who do not want their children or grandchildren to access the money during their lifetime. However, they are not always a must. Below are a few pros and cons to consider before implementing irrevocable trusts:
Pros
- Irrevocable trusts can allow you to carve assets out of your estate even though they may lower your estate tax exemption. If the assets grow substantially in the trust, it will not trigger any additional estate tax because the assets are already out of your estate.
- Irrevocable trusts can allow you to put guardrails around who will have access to your wealth and how quickly they can access it. This is great for spendthrift spouses or troubled children.
Cons
- Irrevocable trusts typically cannot be changed once they are set up and funded. If you change your mind on how the trust is written or who the beneficiaries are, you may be out of luck.
- Many irrevocable trusts do not allow you to access those assets after they go into the trust. If you overfund an irrevocable trust and then run into money problems before you pass, you may have a big problem on your hands.
2. Funding Life Insurance with IRA/401(k) Assets
Hypothetical Case Study
John and Judy have decided that they are going to wait until after they pass for their children to inherit their wealth. They want to maximize what they leave behind for their children but they just do not think their children are ready to inherit it yet. They are also extremely wealthy and have millions in IRA assets that they do not need to live on each year due to their sizable estate.
If they wait until they pass, their children will inherit those assets but they will have to empty the IRA accounts in 10 years and will have to pay the top tax bracket on those dollars due to the size of the accounts. However, if they proactively plan now, they may be able to start drawing down on those IRA funds at a lower tax rate and use them to fund a life insurance policy.
Unlike IRA assets, life insurance proceeds are inherited tax free; furthermore, if they are great planners they could also consider putting the insurance policy inside of a Irrevocable Life Insurance Trust (ILIT) which would also make the proceeds free from estate tax.
In this case study, John and Judy are able to find the best of both worlds through proactive planning. They were able to maximize what they left behind what they left to their children but they were also able to pass along their wealth at what they felt was the appropriate time.
How to Get Your Family Involved
In my experience, the best way to approach the transfer of wealth is through open and honest communication. This may start with a trusted advisor to talk through the pros and cons of your decision, but ultimately it necessitates a conversation with all members of your family. I have found that the following approaches have all been helpful in working through this process:
- Holding a family meeting (with or without an advisor) to discuss how much wealth your children will inherit, how those assets will flow through your estate, and how you hope they will handle those assets.
- Writing a “Wealth Philosophy Guide” with your spouse to tell your children the story of how you built your wealth, the lessons you’ve learned along the way, and the values and legacies you’ve established that you’ll hope they carry on (charitable giving, volunteering, etc.).
- Reaching out to your children individually and talking to them about what they are looking for in life and the hopes/wishes they have for their own children.
There is No One Size Fits All Approach to Generational Wealth Planning
I hope that the amount of options I’ve laid before you drives home the hokey but true cliche that every family situation is going to be different when it comes to generational wealth planning. The combination of the above tactics is going to be completely dependent on the personalities in your family, your relationship with money, the stage of life you are at, and the value system of your family.
You can also see that there are a combination of tax, legal, and emotional consequences to your decision; it may require bringing in multiple professionals to make sure the job gets done right.
Don’t feel like you have to get this done right away because you can’t anyways; this is a process that takes time and patience. But for families that do it right, it will be the greatest planning decision that can live on from generation to generation.
Is Generational Planning Worth it if I am not a High-Net-Worth Individual?
Absolutely. Generational planning is not just about the transfer of your wealth. It is also about the transfer of your legacy and value system to the next generation, and that applies to every family whether you have $1 or $1 billion.
McCabe & Associates Helps Clients Get Ready for the Great Wealth Transfer
Hopefully this article has exhibited that our team here at McCabe has thought deeply about this issue and the several important variables and considerations at play when it comes to the Great Wealth Transfer.
We recognize that families need a trusted ear to listen to their concerns and a sharp mind that can suggest and implement strategies to preserve their wealth across several generations.
As a family business ourselves, we know how important this is and stand ready to meet with you and your family and look forward to the opportunity to maintain and pass on your family’s legacy.
Learn more about our generational wealth planning service.
Disclosures
The hypothetical investment results are for illustrative purposes only and should not be deemed a representation of past or future results. Actual investment results may be more or less than those shown. This does not represent any specific product [and/or service].
The cost and availability of life insurance depend on factors such as age, health, and the type and amount of insurance purchased. Before implementing a strategy involving life insurance, it would be prudent to make sure that you are insurable by having the policy approved. As with most financial decisions, there are expenses associated with the purchase of life insurance. Policies commonly have mortality and expense charges. In addition, if a policy is surrendered prematurely, there may be surrender charges and income tax implications.
Investors should consider the investment objectives, risks, charges and expenses associated with municipal fund securities before investing. This information is found in the issuer’s official statement and should be read carefully before investing. Investors should also consider whether the investor’s or beneficiary’s home state offers any state tax or other benefits available only from that state’s 529 Plan. Any state-based benefit should be one of many appropriately weighted factors in making an investment decision. The investor should consult their financial or tax advisor before investment in any state’s 529 Plan.
