Source: Medicare.gov.
Few people get excited about doing estate planning, even though they might recognize the importance of leaving a legacy for their children and grandchildren. If you want to be smart about making gifts to your loved ones, though, there are some things you should consider before just writing a check.
To reveal some of the secrets of leaving a bequest to your grandchildren, we turned to three Motley Fool contributors to talk about what they've learned about estate planning tips and traps for the unwary. As you plan your own wishes, be sure to keep their thoughts in mind.
Sean Williams: Chances are you've worked hard for your money during your lifetime, and the last thing you'd want to see is your grandchildren squandering their inheritance on something foolish. Admittedly, most grandchildren lack the financial know-how to properly manage money, making the prospect of handing over a large sum of cash or stock a scary proposition. A 2012 National Financial Capability Study demonstrated this with 23% of millennials spending more than they earn, and 31% possessing unpaid medical bills.
The solution? Consider setting up a trust -- which is a particularly smart idea anyway if you're planning to pass along a substantial amount of money and want to avoid any chance of probate -- where a certain amount of money can be doled out to your grandchildren every so often so as not to overwhelm them with cash or stock. Putting money to be inherited into a trust would also give your grandchildren time to mature and develop their financial know-how, so they can properly manage the inheritance when they receive the money, say every five or 10 years.
Source: Flickr user moodboard.
Matt Frankel: If you plan on leaving an inheritance to your kids or grandkids, keep in mind the estate tax, which kicks in if your total estate is valued at more than $5.43 million. And while this doesn't apply to too many households, any amount above this number is subject to tax, which can be substantial.
If this applies to you, you could start giving them some of your money while you're still alive. The IRS allows a $14,000 tax-free gift each year per person. And you and your spouse can each give a gift. In other words, you and your spouse can gift up to $28,000 per year to each person you plan on leaving an inheritance to, and it won't count toward the estate-tax exemption.
Even if you don't plan on leaving enough to trigger the estate tax, it might be a good idea to start giving your grandchildren some of their inheritance a little early. After all, you've saved and invested wisely to leave your loved ones in a good financial position. Wouldn't it be nice if you got to see them enjoying it?
Dan Caplinger: One of the most important things that investors should think about in their estate planning is that any appreciated stocks or other investments that you hold in a regular taxable account get a step-up in basis after your death. What that means, in plain English, is that even if a stock has soared in value since you bought it, your heirs won't owe a penny of capital-gains tax if they sell it immediately after they inherit it.
The tax-basis step-up has implications for your financial planning during your lifetime, as well. Because assets in retirement accounts don't get a basis step-up, it can sometimes make more sense to spend down an IRA or 401(k), even if it forces you to pay ordinary income tax rates on your withdrawals. If, by using a retirement account, you can avoid paying capital gains taxes during your lifetime, your heirs will end up with more assets that aren't unencumbered by future tax liability.
Best of all, if you pick stocks well, you can give your grandchildren a great portfolio that they might choose not to sell, instead continuing the long-term growth track for generations. The basis step-up will nevertheless provide a tax incentive to encourage a long-term investing philosophy more broadly.
