Many people remember growing up, and their parents telling them there won’t be any money left once they are gone, so don’t count on an inheritance! We even hear of wealthy individuals who refuse to give their children an inheritance for fears they will lose their ambition. Parents today are making more money and are interested in leaving a legacy for their children and future generations. Here are ways to ensure the legacy you leave behind is what you intended.
We all know kids are expensive but do we know how expensive? We have the average cost per year of in-state college at $25,000 ($39,000 for private college) plus the $233,610 cost to raise a child in 2017, reported by the U.S. Department of Agriculture. Wow, that will give you sticker shock for sure.
If an account can be created to save for the items below, before having children, then there will be significantly less strain on a budget for the family. Also, it is good to understand the cost of raising children when thinking about purchasing life insurance. We will discuss that in more detail below.
Consider the following child related costs:
- Your baby's first year is estimated to cost about $11,000 for to get equipped with all the baby gear, toys, diapers, formula, etc...Here is a great calculator from BabyCenter.com to help you plan ahead.
- Medical Costs
- Delivery of a baby can range $10,000-$25,000 with no complications
- Changing to a family health insurance plan
- Full-time or part-time daycare
- Before school and after school
- Extracurricular activities
- Music and Arts
- Travel expenses
There are many ways to put money aside for children; both for their well being and for their education. Here are some of them:
These are education savings plans offered by every state within the United States. The state will select the investment manager who will manage the portfolios available for you to choose from on behalf of your child. A parent or grandparent (any adult) can open a 529 Plan sponsored by any state for the benefit of a designated child. The adult is the owner of the account, while the child is a beneficiary. The beneficiary child can change if the adult owner chooses. Maybe the original child doesn’t need all the money or doesn’t go to college; the adult owner can change the beneficiary later so another child can use the money. If you use the money for items other than qualified education expenses you will be taxed on earnings plus a 10% penalty.
Savings and growth within the account will grow tax-free, and no tax will be due with a distribution. The savings must be used for qualified education expenses for elementary, secondary, or college education (max $10,000 can be used for elementary or secondary expenses and no limit on college expenses). The impact on financial aid qualifications is small and offers less of an impact when compared to assets that are in the name of or owned by the child.
Some state plans have contribution limits of $200,000 to $370,000 (based on the cost of a college education), but you will have to confirm with the plan you purchase. We may seem some adjustments to the plan limits since 529 Plans will now be eligible for elementary and secondary expenses.
For those concerned about estate planning, couples can each gift to a child $30,000 per year in 2018 ($15,000 from each spouse). There is an additional exclusion for 529 Plans that states that you can make a $75,000 lump sum contribution (2018) per spouse and it will be treated as if you made a gift of $15,000 for 5 years. Those with estate tax concerns like this exclusion because the lump assets can grow in the child's account for the next five years rather than the sum continuing to increase the size of their estate. If the contributor passes away within those five years, however, they will lose the gift tax exclusion for the remainder of the five years.
These accounts list the child as the owner, therefore, will count as a child’s asset on their financial aid forms, and can be opened like any brokerage account. There is a maximum $2,000 contribution limit per year if you make less than $190,000 and file as married or $95,000 single. Once the $2,000 is reached, no other person can contribute to the account.
Savings must be used for education expenses for elementary and up. If the savings aren’t used for education, or there is money left, there must be a distribution of funds by the child’s age 30, and it would be subject to a 10% penalty and taxes on the growth. The beneficiary of the account can be changed to a child under age 30.
This is an account in a child’s name that does not have to be used for education expenses. This historically has been seen as an account to gift assets to minors. Assets can be used at any time for any reason and the child can access funds on their own after age 18. Anyone can contribute to an UGMA, and there is no annual maximum limit.
There is, however, a tax associated with a distribution. For children under age 19 or full-time students under age 24 the first $1,050 is tax-free, The next $1,050 is taxed at the child’s tax rate, and anything after $2,100 is taxed at the parent’s rate.
Children can open and contribute to a Roth IRA for tax-free savings and distributions in retirement if they have earned income which they may claim on a tax return or file self employment taxes on for the year. The income must be proven as earned income during the year, rather than say an allowance. Children can only contribute up to their earnings or the annual $5,500 max, whichever is less.
Parents can save into a taxable account in their name or set up an account in their child’s name with a parent as a trustee and begin making unlimited contributions to the account. The account will be taxed on gains and dividends, and if the account is in the child’s name, it will count against them for financial aid eligibility.
There is no advantage to putting an account like this in a child's name unless the money is being gifted to them and all other child savings options are maximized. Once the child reaches age 18 or 21, depending on the state, they will take ownership of the account. Taxes will be owned if there is a capital gain or dividends earned. The child or parent can pay these taxes. See your tax advisor for the best ways to handle taxes due because of investment income and gains for a child's account.
Trust accounts are accounts with a person’s assets in them, which will have a trustee assigned to it to manage its assets on behalf of a beneficiary. For example, if John wishes to ensure his child will inherit $1,000,000 at his death, but his child cannot manage the money, he could assign his brother as a trustee to manage the account on his child’s behalf.
Assets will pass to a trust without having to go through probate. Probate is the process courts use to prove a will and value the assets of the estate. Probate can take six to nine months. It is important to understand the types of trusts that exist:
- Living Trusts – a trust that exists during the grantor’s lifetime. A grantor (or the contributor of assets) may act as a trustee or appoint another person like a family member, attorney or accountant. A living trust may be revocable or irrevocable. Revocable means the assets may be taken away and returned to the grantor, and an irrevocable trust means that the assets are permanent.
- Testamentary Trust – a trust that is established upon the death of the individual with the assets. A trustee will be assigned, like with a living trust, and the trustee will have an obligation to act in the best interest of the beneficiary.
The above discusses preparing for your future generations but what if someone gave you an inheritance? One of the most common forms of an inheritance is a parent's IRA or personal property. When your receive the assets they will be valued at the date of death and used as the new cost basis for the individual receiving the items as an inheritance. Any gains or income earned beyond the new cost basis is taxable for the new owner. If the assets are in an IRA, the distributions will be taxed like income.
When an individual reaches age 70 1/2 the IRS will require them to take minimum distributions (RMD) each year from their retirement accounts. A spouse will take an inherited account as their own and therefore apply their age 70 1/2, but non-spouse beneficiaries must calculate a new required minimum distribution schedule if the account never began taking them. If the account already began RMDs, then the RMD must continue when the beneficiary takes over ownership of the assets. See your tax advisor for when to begin taking RMDs and how much is required.
We all want to be sure our loved ones don’t have to worry about us when it is our time to pass. Whether we are preparing for ourselves, our parents, or another loved one, there are some things you should do now to help you be ready to make these decisions. Think about the following list:
- Consider getting life insurance to provide for basic needs, child care, funeral expenses, and pay off any debts, such as a mortgage. Think about the income you bring to the family and how many years of lost income you will want to provide for with insurance. Once someone is retired, it is difficult to justify paying for life insurance. If the survivor benefits of retirement pensions and other accounts will not cover the income need of a surviving spouse or family, then it would be appropriate to consider keeping some life insurance. Obtaining a new policy can be very costly after you retire.
- Decide who you would want to make decisions about your medical care if you cannot. Tell the family who will be designated.
- Decide who you wish to take care of your money needs. Tell the family who will be designated.
- Decide who you will want to care for your children. Tell the family.
- Decide where you want your final resting place to be or if you would rather prefer cremation. Get an understanding of what the funeral and burial costs will be for your preferred place.
Once you know these answers and have discussed them with your designated persons, it is time to create a will. An attorney can help you create the necessary items for $300 to $3,000 depending on how complex your situation is. If you are helping someone else you should review these items with them and double check the person designated in each are still their preferred person. Here is what you will want to receive or review:
- Durable Power of Attorney – allows a designated agent to manage your finances
- Release of Information Form – allows doctors to share your medical records with designated individuals
- Advanced Directives
- Durable Power of Attorney for Health Care – names a person to make medical decisions on your behalf
- Living Will – states what treatment you want at the end of life, such as do not resuscitate orders
We mentioned earlier that probate was the process of transferring and valuing assets within a person’s estate. Life insurance benefits, investment accounts with assigned beneficiaries, and jointly owned property will not be subject to probate because they all have designated beneficiaries. When a beneficiary inherits an asset, it is not taxable. The gains earned from the inherited date, or date of death, going forward will be taxable.
Part of personal financial planning is thinking about your legacy and how you want to share your assets upon your passing. Talk to an accountant and an attorney about you’re your plans and wishes. They can guide you through the ramification of those wishes and if there is a better way to approach your legacy goal. Your parents or loved ones need to go through this process as well and may need you to help them prepare. Don't put off the preparation, it will be much easier for family to discuss items of concern now rather than during a grieving process.