8 Ways to Pass on an Inheritance
Estate and inheritance planning offers the opportunity to create a lasting legacy while also ensuring the financial security of your heirs. However, passing on an inheritance can be complex and requires careful consideration to ensure that the wishes of the deceased are met, while also ensuring the interests of beneficiaries are protected. Although a will is the standard method of transferring assets, there are several other ways to do so, such as trusts, joint ownership, gifting, and more.
A financial advisor can offer guidance on how to transfer assets through an inheritance. They can also help with tax planning, ensuring that the transfer of assets is done in a way that minimizes tax liability for both the estate and the beneficiaries. Professional advisors and estate planners can also help navigate complex legal and financial issues related to inheritance. Consider consulting with a professional financial advisor who can help ensure that your inheritance is passed on to your beneficiaries as per your wishes.
This article discusses eight ways you can pass on an inheritance so you can help determine the best approach for passing assets to your heirs before their death, or after their demise.
How to pass on an inheritance
There are several ways through which you can pass on an inheritance. These are:
1. Create a will
A will is a legal document documenting how a person’s assets will be distributed after their demise. The will specifies the beneficiary, the portion or amount they shall receive, and any other conditions that need to be met. It can also name an executor who will manage any estate and carry out the instructions outlined in the will.
That said, laws pertaining to wills may vary from state to state and drafting a will may not guarantee that your assets are distributed according to your wishes.
There are primarily three types of inheritance laws:
a. Common law: Under common law, marital assets are not automatically split equally between spouses in the event of death. However, some states provide the surviving spouse with a right to claim a portion of the deceased’s estate even if it goes against the will, provided they file a petition with the court. Common law also states that the ownership of property is determined by the titleholder or the source of funds used to acquire it.
b. Community property: As per community property law, each spouse is automatically considered to own half of what was earned during the marriage and upon death, half of the deceased’s estate goes to the surviving spouse. This law is enforced in 9 states namely, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. However, the deceased can choose to leave more than half of their assets to their spouse through a will. Property acquired during a marriage or any income earned is considered shared for inheritance purposes. On the other hand, any property acquired before marriage or after legal separation, inheritance, gifts, or assets kept separate are excluded.
c. Elective community property: Alaska, Tennessee, and Kentucky are three states that have different inheritance systems than common law and community property. These states have an elective community property system that enables spouses to inherit automatically by creating a written agreement and a community property trust with their partner. Residents and non-residents can establish community property through a trust in these states. This unique inheritance system grants equal ownership rights to both spouses on any property acquired during the marriage, including income from work, inheritances, and gifts. The agreement can also specify the distribution of property in the event of a spouse’s death.
2. Set up a trust
Trusts are a highly popular option for passing on inheritance because they offer greater control over the distribution of assets to beneficiaries. By establishing a trust, you can specify how and when your assets will be distributed to your beneficiaries. This is especially beneficial if you have concerns about your beneficiaries’ financial management skills or if you want to protect your assets from creditors. It may be wise to appoint a trustworthy financial advisor or company to manage the trust for you and oversee distributions.
There are several trust types that can be used for inheritance planning. The four primary types of inheritance trusts include:
- Revocable living trusts: These trusts allow the grantor to retain control over the assets during their lifetime. The grantor can change or revoke the trust or the assets at any time. Upon the grantor’s death, the assets in the trust are distributed to the beneficiaries named in the trust.
- Irrevocable trusts: The grantor cannot change or revoke these trusts once they are created. The assets in the trust are transferred out of the grantor’s estate, which can reduce estate taxes. There are several types of irrevocable trusts, such as irrevocable life insurance trusts (ILITs), charitable trusts, and special needs trusts.
- Testamentary trusts: These trusts are created through a person’s will and go into effect upon their death. The assets are distributed to the trust, which is managed by a trustee for the benefit of the beneficiaries mentioned in the will.
- Charitable trusts: These trusts are created to benefit a charitable organization or cause. There are several types of charitable trusts, such as charitable remainder trusts and charitable lead trusts. These trusts can offer tax benefits to the grantor.
Trusts are most commonly used to pass on an estate to children, in which case a revocable trust is ideal. If you have a large amount of wealth that you want to pass on to your children, consult your financial planner about setting up a trust that can automatically be passed on to your heirs after your demise.
Also see: How to Handle a Large Inheritance
3. Add a joint owner
If you have a property that you want to pass on to a specific individual, adding them as joint owners of the property is one way to accomplish this. By doing so, they automatically inherit the property upon your demise since they are part owners.
However, it’s essential to consider the legal and tax implications of joint ownership. If you don’t want the beneficiary to have any control over the property while you’re alive, joint ownership may not be the best option since it grants them a certain amount of control over the property. Additionally, owning a property involves indirect costs like taxes and maintenance expenses. It is advised to consult an attorney or a financial advisor before making this decision.
4. Invest in a retirement account
Passing on assets as inheritance can be made easy by investing in a tax-free retirement plan. Employer-sponsored tax-deferred retirement accounts, such as IRAs and 401(k)s, are among the most popular options. If you’re already contributing to one of these accounts, consider speaking with a financial advisor about maximizing your investment.
Although these accounts are intended for retirement, they allow you to designate a beneficiary, making them an effective way to pass on an inheritance. Upon your passing, the assets saved under your retirement account can be transferred to your beneficiary without undergoing the probate process. Your beneficiary will have several options for managing the inherited funds, including rolling the IRA or 401(k) into their account, transferring the funds directly to their bank account, or leaving the account as-is to continue growing. However, note that leaving the assets untouched for more than ten years will require withdrawing the full amount.
5. Consider giving gifts
Giving inheritance in the form of gifts can be a good idea if you have financial leverage. Gifting assets to your beneficiaries during your lifetime can help reduce the size of your estate and lower the tax burden for your heirs. Currently, the annual gift tax exclusion is $17,000, which means you can give a gift equal to that amount without incurring a gift tax. However, it is advised to consult with a professional who can help you understand the gift tax regulations before you give a large amount of money as a gift, as the beneficiaries may face capital gains taxes.
If you’re gifting to children or grandchildren, establishing a Uniform Transfers to Minors Act (UTMA) or Uniform Gifts to Minors Act (UGMA) account can be beneficial. These accounts are custodial savings accounts for minors, and the assets are transferred to the beneficiaries once they reach legal age. UTMA accounts can hold any asset, while UGMA accounts only contain financial assets. Setting up these accounts can be tax-efficient since the beneficiaries will be taxed at a lower rate on their gifts.
6. Buy a life insurance policy
Life insurance policies can be another way to pass on an inheritance. There are two primary types of life insurance: term and permanent. Term life insurance provides coverage for a specified period, while permanent life insurance provides coverage for the duration of your life. The major con associated with term insurance is that if you outlive the designed period, no payout shall be made to your beneficiary.
When you purchase a life insurance policy, you designate a beneficiary or beneficiaries who will receive the death benefit. The death benefit is typically tax-free however, the life insurance payout in some states may attract taxes. Do consult with your advisor before making any decision.
7. Make charitable donations and set up a special needs trust
Charitable donations are one of the most popular ways to pass on an inheritance and lower the tax burden on your estate. Charitable donations can be made through your will or trust, or you can set up a charitable foundation in your name.
In addition, if you want to pass your inheritance to a loved one with special needs, you can set up a special needs trust. This type of trust allows for the transfer of assets without affecting the individual’s eligibility for government benefits such as Medicaid or Supplemental Security Income. To establish a special needs trust, it’s crucial to consult with an experienced attorney who can help set up the trust, select a trustee, and create a detailed plan for using the trust funds. The trustee will manage and use the funds to provide for the individual’s needs, such as medical care, housing, and transportation. Setting up a special needs trust ensures that your loved one with special needs is taken care of for years to come.
Also see: 17 Principles For Creating Wealth
8. Establish an education fund
Creating an education fund can be a good way to pass your inheritance and invest in your loved ones’ future education. There are various ways to establish an education fund, such as setting up a trust with your intended beneficiaries or opening a 529 college savings plan, which allows for tax-free growth of funds as long as the money is used for qualified education expenses. You can also consider creating a Coverdell Education Savings Account or a custodial account under the Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA).
Ensure that you set clear guidelines and instructions for how the funds should be used and accessed. This can include requirements for maintaining a specific grade point average or pursuing a particular field of study. Doing so will help you set your beneficiaries up for success and leave a lasting legacy for your family.
What is the best way to pass on an inheritance?
Each individual may have a unique situation or idea for passing on an inheritance based on their assets, accumulated wealth, debt, family relations, and more. For instance, some may have children or grandchildren to leave their assets to; others may want to support a charity or cause they are passionate about. Irrespective of the situation, it is important to carefully consider how to pass on your inheritance to ensure that your wishes are fulfilled, and your loved ones are taken care of.
Before passing on your inheritance, there are several factors to consider. First, think about the age and financial situation of your beneficiaries. Will they need the funds immediately, or can they wait? Do they have any outstanding debts or financial obligations that need to be considered? Additionally, it is essential to consider any potential tax implications of your decisions. Depending on the size of your estate, your beneficiaries may be subject to inheritance taxes or other fees.
Ultimately, the best way to pass on your inheritance depends on your specific situation and priorities. Consult with a financial advisor who can create a plan that meets your needs and ensures that your legacy lives on.
Ensuring a smooth transfer of assets as inheritance is critical to ensure control over your legacy, while also providing for your loved ones’ financial well-being and security. By taking proactive steps and seeking the assistance of experienced professionals, individuals can navigate the complexities of inheritance and create a solid foundation for the future. Consider reaching out to a professional who can set up an estate plan for you based on your wishes such as setting up trusts, gifting assets to your heirs, or exploring life insurance as a form of inheritance. You can create an effective, personalized plan aligning with your goals with expert guidance.
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