You've worked hard over the years to accumulate wealth, and you probably find it comforting to know that after your death the assets you leave behind will continue to be a source of support for your family to meet their financial need.
But to ensure that your legacy reaches your heirs as you intend, you must make the proper arrangements now. In this article, we’ll break down the three main ways to pass an inheritance to your children, as well as other important topics like estate and inheritance tax.
How to Pass on Inheritance
There are three basic ways to leave a legacy to your children: by will, by trust, and by beneficiary designation. Here’s what you need to know about these methods.
1. Passing Inheritance to a Child with a Will
A will is the cornerstone of any estate plan. You should have a will no matter how much your estate is worth, even if you've implemented other estate planning strategies. There are several benefits to a will: it distributes property according to your wishes, names an executor to settle your estate, names a guardian for young children, and can create a trust.
You can leave property by will in two ways: making specific bequests and making general bequests. A specific bequest directs a particular piece of property to a particular person ("I leave Aunt Martha's diamond broach to my daughter, Jen"). A general bequest is typically a percentage of property or property that is left over after all specific bequests have been made. Typically, principal heirs receive general bequests ("I leave all the rest of my property to my son, Jim").
With a will, you can generally leave any type of property to whomever you wish, with some general exceptions:
- With some types of property, if it already has a specific beneficiary designation, it will pass to that beneficiary—even if you name a different beneficiary for the same property in your will
- Property that is owned jointly with rights of survivorship passes directly to the joint owner
- Property in a trust passes according to the terms of the trust
- Your surviving spouse has a right to a statutory share (e.g., 50%) of your property, regardless of what you leave him or her in your will
- Children may have specific inheritance rights in certain states
A word of caution about wills: Leaving property outright to young children can be problematic. You should always name a custodian or property guardian or use a trust for minors.
2. Passing Inheritance to Your Children with a Trust
You can also leave property to your heirs using a trust. Trust property passes directly to the trust beneficiaries according to the trust terms. There are two basic types of trusts: living or revocable and irrevocable.
Living trusts are very flexible because you can change the terms of the trust (e.g., rename beneficiaries) and the property in the trust at any time. You can even change your mind by taking your property back and ending the trust.
An irrevocable trust, on the other hand, can't be changed or ended except by its terms, but can be useful for tax purposes or to protect your property from potential creditors.
You create a trust by executing a document called a trust agreement (you should have an attorney draft any type of trust to be sure it accomplishes what you want). A trust can't distribute property it does not own, so you must also transfer ownership of your property to the name of the trust. Property without ownership documentation (e.g., jewelry, tools, furniture) are transferred to a trust by listing the items on a trust schedule. Property with ownership documents must be re-titled or re-registered.
You must also name a trustee to administer the trust and manage the trust property. With a living trust, you can name yourself trustee, but you'll need to name a successor trustee who'll transfer the property to your heirs after your death. A living trust is also a good idea if you’re looking to protect your property in case you become incapacitated for whatever reason.
3. Passing Inheritance to Your Children with Beneficiary Designations
Property that is contractual in nature such as life insurance, annuities, and retirement accounts, passes to heirs by beneficiary designation. Many bank accounts and investment accounts also work this way. Typically, all you have to do is fill out a form and sign it. Beneficiaries can be persons or entities, such as a charity or a trust, and you can name multiple beneficiaries to share the proceeds.
You can't change the beneficiary with your will or a trust. You must fill out and sign a new beneficiary designation form. Keep in mind that some beneficiaries can't be changed. For example, a divorce decree may stipulate that an ex-spouse will receive the proceeds for specific property.
You should consider the income and estate tax ramifications for your heirs and your estate when naming a beneficiary. For example, proceeds your beneficiaries receive from life insurance are generally not subject to income tax, while your beneficiaries will have to pay income tax on proceeds received from tax-deferred retirement plans (e.g., traditional IRAs).
Check with your financial planning professional to determine whether your beneficiary designations will have the desired results. Be sure to re-evaluate your beneficiary designations when your circumstances change (e.g., marriage, divorce, death of beneficiary).
The Best Way to Leave Money to Heirs
There is no one “right” way to pass your money and property to your heirs. Passing money to heirs can get a little complicated, which is why it is always best to work with a financial advisor to come up with a plan. What might work best for your friend might not be the best course of action for you and your heirs.
What You Need to Know About Taxes on Your Estate
Another thing that might be looming large on your mind are estate taxes and how they will affect your children.
Please note: CUSO Financial Services, L.P. (CFS) does not provide tax or legal advice. For such guidance, please consult your tax or legal advisor.
What is an estate tax?
In short, an estate tax is a tax levied on the current value of your estate before it is distributed to heirs. This tax is assessed by the federal and some state governments.
The good news is that not all of your estate is subject to estate tax— only the value of your estate that exceeds a set threshold. On the federal level, estate taxes will be levied on assets in excess of $12.06 million in 2022. So if your estate is worth less than that amount, you’ll be exempt from the tax!
What is inheritance tax?
Inheritance taxes are different from estate taxes. Instead of being levied against your estate, inheritance taxes are paid by your heirs based on what they receive. How much your heirs will be liable for will depend on their relationship to you and the amount of the inheritance that they receive.
Luckily, there is no federal inheritance tax. Only six states have this tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
Tax benefits and rules change annually. If you’d like to make sure your will is still accurate and doesn’t put your heirs at a disadvantage, review your paperwork yearly or have your financial advisor schedule periodic updates.
Leave Your Legacy
Estate planning is an important thing that many people don’t start thinking about until later in life. It can be easy to put off estate planning for a later date, but the truth is, we don’t know what tomorrow holds. To ensure that your money and property goes where you want, get started on your estate planning today by contacting a CFS* financial advisor who can guide you through the process.
* Non-deposit investment products and services are offered through CUSO Financial Services, L.P. ("CFS"), a registered broker-dealer Member FINRA/SIPC and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. The Credit Union has contracted with CFS to make non-deposit investment products and services available to credit union members.
CUSO Financial Services, L.P. (CFS) does not provide tax or legal advice. For such guidance, please consult your tax and/or legal advisor.