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Many of us dream of leaving some of our money and possessions to our children, but just as with most other personal-finance topics, there are right and wrong ways to do this. We asked three of our contributors to offer some advice on the matter, and here's what they had to say.
Use the gift tax exclusion
Matt Frankel: First of all, it's important to point out that estate taxes apply only if your estate is valued at $5.45 million or more. This includes property (such as houses) in addition to cash and investments, and this lifetime exemption amount applies to property you give away while you're alive, in addition to what you pass on.
Having said all that, the IRS allows an annual gift exclusion of up to $14,000 per person that isn't counted toward this limit. You can give as many $14,000 gifts as you want each year to reduce the taxable value of your estate in the eyes of the IRS.
For example, let's say that you have two children, their spouses, seven grandchildren, and a total of five nieces and nephews. You can legally give these loved ones a total of $224,000 every year tax-free. If you do this for several years, that's millions in wealth you can pass along tax-free. Better yet, if you're married, you and your spouse can each give a $14,000 annual gift (and you'll have double the lifetime exemption).
Between the gift-tax exclusion and the other methods my colleagues describe, you can shelter a large portion of your wealth from the IRS.
Make them money-savvy
Selena Maranjian: One of the best ways to pass wealth on to your descendants is an indirect one: Make them financially savvy. That way, they can make themselves financially independent and they're less likely to lean on you or anyone else for fiscal support.
There are many ways to help kids grow up smart about money. A key tactic is to talk about money frequently, when it's natural to do so. If you're paying bills, you might show them how much some things such as electricity or car insurance cost. Let them watch you shop, too. For example, if you're going to buy a new computer, they might watch or even help you research your options, comparison-shop for the best prices, and then perhaps buy using a credit card that gives you cash back. If they learn to be smart consumers while they're young, it can save them much money over the rest of their lives. Teach them about the dangers of excessive or expensive debt, such as credit card debt -- either by your own experiences or other cautionary tales.
You can start them investing at a young age, perhaps just on paper or in an actual custodial account with a brokerage. Discuss companies together and follow them in the news. Let them start out investing in the companies they know and like -- such as, perhaps, Chipotle Mexican Grill (NYSE: CMG) or Amazon.com (NASDAQ: AMZN). Had they invested in Chipotle a few years ago, they could have watched how illness outbreaks sent the company's shares down and how the company responded to the challenge. Help your kids appreciate the power of compounded growth -- and the edge they have in starting to invest while still young. Even just an annual investment of $1,000 can be powerful if it has, say, 40 years to grow -- from age 15 to 55. At an annual average rate of 8%, it can grow to about $280,000!
Simplify the process of divvying up your wealth when you're gone
Jason Hall: My wife and I are far from wealthy at this stage of our lives, but we want to make sure that what wealth we do leave behind is as easily divided up and paid to our heirs after we die as we can make it. And one tool that can make this easier is a revocable trust.
The basic idea is that since a trust is a freestanding legal entity, using it as a tool to hold your assets, such as real property, bank accounts, and other valuable items, the process of going through probate -- which can be both costly and very time-consuming -- can be largely avoided.
Setting up a revocable trust takes some time and expense, but for anyone who owns a home, has a large cash-value life insurance policy, or holds other assets that would be part of their estate and would have to go through probate, the up-front time and cost of creating a revocable trust would almost certainly benefit those you leave behind.
