By Dr. James M. Dahle, WCI Founder
Estate planning is on my mind. Our big financial goal for 2021 was to get our estate planning done. Our audience has done a lousy job of keeping us accountable, however, since it took us until November to actually make the appointment with the attorney. We first reached out in February 2020, but then there was kind of a pandemic and we put everything off. In October 2021, I emailed the paralegal back, “I know it’s been 18 months since you sent us this email, but you know, COVID. We’re back! Can we still get an appointment?”
So, I guess the first lesson you should learn from this post is that whatever you’ve been putting off—an estate plan, refinancing your student loans, doing that rollover, completing your Backdoor Roth IRA, buying insurance, or deciding on an asset allocation—just do it!
Aside from overcoming inertia and general busyness, the other reason we put off the estate planning for a few months was that we were having trouble deciding exactly what that estate plan should look like. You see, before you go to see the estate planning attorney, you actually need to decide what you want to happen to your kids, your money, and your stuff when you die—especially if you die early. Once you know what you want to do, the attorney’s job is relatively easy. If you have no idea, you might waste a lot of billable hours trying to decide.
3 Big Decisions About the Inheritance
There are three big decisions we, and everyone else who wants to leave an inheritance, will need to make. The best estate plans provide the most flexibility on these issues, but the better an idea you have about these three big decisions, the easier the process will be. Naturally, the longer you live, the more finely you can tune this, but since you never know if you will die an untimely death, you will need to make these decisions earlier than you would like. There are no right answers to any of these three questions, only the right answer for you.
#1 How Much Inheritance Money to Leave to Your Children
The first big decision is relatively simple: “How much do you want to leave behind to your kids?” For most people, this is really easy: they want to leave everything behind that they did not need themselves. This is a very simple proposition if your estate size is less than the federal tax exemption ($12.06 million per person in 2022) and any applicable state estate tax exemption amount, and if no inheritance taxes will apply. You just need a will and, if you want to avoid probate, a revocable trust.
If you have more than one child, you will also need to decide how much goes to each of them. While the most common thing to do is to simply divide the estate by the number of kids, there are plenty of families that do not do this. They leave less to some kids than others, due to need or due to the decisions their offspring have made during their lives.
If your estate size is more than federal and state estate tax exemption amounts, this is where the attorneys can really earn their fees. Since you are trying to leave as much as possible, that means reducing your estate tax, inheritance tax, and income tax as much as possible. There are lots and lots of techniques you can put in place to do this.
However, there are many people, including us, that do not want to leave our children the maximum possible amount. In fact, we plan to leave more to charity than to our children. We wrestled with how much we really wanted to leave them. This was particularly important in the fall of 2021 when Congress was discussing reducing the estate tax exemption amount. If we wanted to leave them more than the estate tax exemption amount, we would need to implement a fairly complex plan to take advantage of the temporarily higher estate tax amount.
In the end, we decided to leave no more than even the new, lower estate tax amount. We subscribe to Warren Buffett’s theory on inheritances—we want to leave enough money that our kids can do anything they want, but not so much that they can do nothing. That amount might be different for everyone, but in our view, it was less than the estate tax exemption divided by four. Besides, if we don’t die an untimely death, we can always arrange for them to have more via gifting into irrevocable trusts. One of the best parts of leaving less than the estate tax exemption amount to anyone but charity is that it can dramatically simplify estate planning. Of course, keeping the option to give more later (especially if the exemption amount goes down) means you end up with the complex plan anyway.
#2 When to Give Inheritance Money to Your Kids
The next big question we needed to answer was when we wanted our kids to receive the money. If we live a long time, we can decide this as we go along depending on how ready they are to take care of it. In fact, if we live a long time, they probably will not get most of their inheritance until we are gone. However, an estate plan has to take an untimely death or two into account.
We decided a long time ago that an inheritance is far more useful in your 20s than in your 60s, but we are also very well aware that dumping a bunch of money on a 20-something is a great way to ruin their life. So, we decided that they would not get most of their inheritance in their 20s but that they would get some of it. That inheritance comes in the form of three accounts:
- 529 Account: To pay for their educations
- Roth IRA: Where we put their WCI-related salaries and match their earnings
- UTMA Account: The 20s fund, to pay for all of those things we would use the money for in our 20s if we actually had any money: college, grad school, study abroad, summer in Europe, missions, weddings, honeymoons, cars, down payments, etc.
Beyond that money for their 20s, we don’t want our kids to have access to large amounts of cash for decades. While it will be easier to determine when they are ready for it if we live a long time, we had to figure out when we want them to get their inheritance if we keel over tomorrow.
We decided we did not want them to have it all at once. That way, if they screw up the first one they receive, they will eventually receive some additional boluses. Honestly, we do not view this as money for them to use. If bad things happen to them in their lives, they will have that option. But we hope that by the time they get most of this money, they will have already made it on their own and will view themselves as stewards of this money for the next generation. We decided to give them 1/3 of the money at 40, 1/3 at 50, and 1/3 at 60, keeping it invested in a trust on their behalf in the meantime. They will also have the option to leave it in the trust until they want it, providing significant asset protection for them.
#3 How to Control How Heirs Spend Your Money. Do You Want Restrictions?
Many people put plenty of restrictions on the money to encourage their children to live their lives in the way the parents would prefer. You have to balance that with the unintended consequences of ruling from the grave. We decided we didn’t want to put too many restrictions on the money but do want to make sure they prove themselves financially literate before getting that first bolus of money. I thought about writing a financial literacy test they would have to pass to get it (and still may if I'm alive when they hit those ages). But for the trust, the requirement is to pass a financial literacy course chosen by the trustee such as this one put on by our alma mater.
You may decide these questions completely differently than we did. That’s perfectly fine. Just like a financial plan should be personal, so should an estate plan. However, you will need to make these decisions to have an estate plan worth anything at all.
Have more questions about estate planning or protecting your assets? Hire a WCI-vetted professional to help you sort it out.
What do you think? How much will you leave to your kids? How will you leave it? What will they need to do to get it? Comment below!
WCI will your trust address legacies for grandkids? Have you decided if you will give per stirpes or per capita? I can’t decide which is fairer- why reward having more kids, punish not doing so? Ask me later when I may want more grandkids… I am undecided about college money for them- the first one genetically could get either an athletic OR an academic scholarship anyway and we overfunded our own kids’ 529s given their scholarships and the GI bill. (Don’t have one still to pass on- we used both kids’ 529s and her Educational IRA to pay for the oldest’s legitimate expenses and now with GI bill are expecting the youngest may pay taxes on her EIRA and never use it for school.)
My best friend gives equal shares to her kids and their spouses in her will. I am still leery of that- I almost want to pay for a trust so a son-in-law doesn’t get ¼ our fortune if they divorce.
Our current issue is a 7 year age gap. We already owe the youngest a new car, a wedding, a bit toward buying a house, and another year of college, not to mention several items of furniture that saved the oldest $100s and would have been $1000s had she wanted all the items new. I address that with a higher percent of retirement funds, and adjust the difference as we get closer to parity.
More so, while we have no 20s fund beyond $X in last paragraph, the older is often in a place where we consider giving her more that the younger still has no use for. Recently as she was telling us about home remodel plans, and how her spouse didn’t agree to budget the cost of something she wanted, I discussed with my spouse whether our Xmas present should be several $1000s so they could easily afford it. He pointed out it could change their marital dialogue into “Well it’s money from my parents so I get what I want.” Several months later I disclosed this decision to the kid’s spouse. I can’t tell from his reaction if he is glad we didn’t tip the argument against him or sad they didn’t get a lump sum from us. We did humorously discuss that any money given them should be for them both to decide about equally- eg that they might get new jet skis instead of the house remodel with the money. Did NOT disclose but certainly agree that if they come to us (jointly) requesting a loan or a gift for a purpose we are likely to agree (just need to adjust the youngest’s inheritance upward again).
Yes.
https://www.whitecoatinvestor.com/spousal-lifetime-access-trust/
We mostly favor per stirpes for our kid’s inheritances but at the next level, it’s per grandkid (none of which currently exist). The 529s will probably pass through too.
Yes, to guard against divorce is a great reason for a trust.
Emphasize to your kids that life isn’t fair because you’ll never get a perfect split.
We set up our trusts using the same reasoning over twenty years ago when our kids were aged 2-6. We did place a performance bonus at age 30 of an early 25% provided they had graduated with a 2.75 GPA and worked 13 months after graduation. We allowed that acceptable progress in a course of study in law or medicine would suffice as employment.
That’s a cool provision.
Really?
In general, which assets should be placed in a trust (revocable or irrevocable)? I have heard some say to only place your home and your taxable investments in your trust, and make your trust the beneficiary of your retirement accounts. Others say to put every financial account you have into the trust to avoid probate. Does it really matter that much?
I think that is generally right. You don’t need retirement accounts in there to avoid probate.
If you have grandchildren, then I think a wise use of inheritance is to pay for the grandkid’s primary, secondary, and college tuitions. It relieves a lot of the financial stress on your children without giving them cash outright. It also avoids the issue of giving to in-laws which a prior poster mentioned as a potential sticking point for them.
Also established a Revocable trust for my family. Have 2 kids (22 months apart in age) who will be getting equal amounts from the trust at ages 25 and 35 years. It was easy to give equal amounts more so due to emotional maturity (younger daughter more mature than older son). However, with pushing the time frames this far, I struggled with controlling too much “from the grave”. Ultimately felt that it gave them some room for error so to speak at the start of their professional life to make decisions and enjoy some of the money at a time they may want to travel, buy a house, or go back to school for an advanced degree…Dr Dahle, did you find that your estate plan needed provisions for who would oversee the trust disbursements over the extended time until they were 40, 50 and 60 (and the payments of fiduciary/counsel fees associated with that governance into those late ages)? Thanks
Yes, we named a trustee to manage all that.
WCI
Thank you for the great post.
Just remember, it is OK to change your mind on estate planning as life changes can happen.
Totally agree and it will almost surely happen based on who our kids become in their 20s.
Another consideration for setting up a child’s trust is that 50% of marriages end in divorce, with the possibility of a former spouse walking away with 1/2 of the trust. We established the need for a spousal pre-nup in order for the child (and by extension grandkids) to obtain 100% benefit from the allotted trust. Otherwise the majority of the trust will be allocated elsewhere, including charities.
You can also just set up the trust so that only the child is the beneficiary. So in the divorce, the ex doesn’t get any of it, at least any of it that wasn’t taken out of the trust.
In theory, you’re correct about sole beneficiary. However the legal wrangling around an asset brought to the marriage, e.g. in “community-property” states could be challenging. Clearly putting everything in writing upfront was our preference
Great post. I agree that you have to make some difficult decisions and it’s hard to predict the future. We set up our trust when kids were young and fortunately no one has “jumped the tracks”. We chose to give them $ in stages when we croak, at 25, 35, and 45 (but they’re all now 27-33 now). Only other clause is no one gets $ if they’re deemed to be substance addicted by a majority of the executor and other kids). No $ to spouses specified and equal $ to each regardless of # of grandchildren. We have annually gifted some $ already because I know from experience that receiving $ when you’re young is more impactful. But we remind them the best thing we’ve done is paid for all their colleges and 2 state Med schools and bought their first cars—and bought the White Coat Investor book for all of them!
Hi Jim,
You mention leaving 1/3 of your inheritance for your kids at ages 40, 50 and 60. Since IRA distributions must be completed within 10 years of owner’s death, how can you stretch it out this long?
Thank you,
Mark
The trust is the IRA beneficiary. So it’ll get stretched as long as possible, then it’ll be in a taxable account in the trust.