Leaving a lasting legacy for the next generation is a common goal among investors in retirement.
Considering the financial well-being of your children and grandchildren, how much money to leave them, and the best strategies for leaving them an inheritance are all critical considerations when planning for the future.
But how much is too much? Should you give them some money now, and if so, when and in what capacity?
To quote George Clooney from the movie Descendants: "You give your children enough money to do something, but not enough to do nothing."
While I agree with Mr. Clooney here, the reality is that estate planning is a bit more complicated than following a pithy line of dialogue in an Alexander Payne movie.
Transferring your retirement savings to your grandkids, while a thoughtful and impactful way to support their future, should be carefully thought out and planned. This guide will explore various strategies, considerations, and steps to effectively leave your retirement savings to your grandchildren.
Key Takeaways
Ensure your retirement plan and financial goals are in order first, then start to formulate strategies to leave money to loved ones.
Take an inventory of all your financial accounts and determine how much money you'd like to leave each grandchild while being mindful of their spending habits, financial well-being, and tax situation.
Review your estate plan, including beneficiaries listed on your retirement accounts, along with your specific goals with a tax professional, financial advisor, and/or estate attorney, and discuss options to consider moving forward.
Once you've selected the options you feel are best suited to achieve your objectives, your estate attorney and financial advisor will assist in implementing your plan so that your legal documents appropriately reflect your intentions.
Review and monitor at least once every two to three years.
Strategic Planning Steps
Before making any decisions, it's always important to evaluate your own financial stability.
At the very least, make certain you have enough to cover your retirement needs, including healthcare, living expenses, and any potential long-term care costs. Overextending your generosity could compromise your financial security.
After assessing your financial health, here are 5 strategic planning steps to consider:
1. Define Your Goals
Clearly define what you want to accomplish by leaving money for your grandchildren. Are you focused on their education, providing a nest egg for their future, or both? Do they have spending issues or are they well-off? Clarifying your goals and understanding your grandkids' financial situation are critical considerations when assessing the best method for transferring your savings.
2. Take an Inventory
Once you have goals established, the next step is to get organized.
Take an inventory of your financial assets and how they're classified, i.e. traditional IRA, Roth IRA, 529 plan, etc., as certain accounts can be directly transferred to your grandchildren based upon the beneficiary designation while others require separate documents altogether.
Additionally, being organized can save you billable hours in the next step.
3. Consult with Financial and Legal Advisors
Once you have a good picture of the household finances, now is the time to engage with a financial advisor, tax professional, or an estate attorney, preferably one with a niche or specialty in tax, estate, and trust planning, to review your current plan and provide options
for tax-efficiently transferring your assets to your kids and grandkids.
4. Choose the Appropriate Method
Based on your goals and the advice of your advisors, determine the best course of action to take and update your estate plan accordingly. You'll want to consider the pros and cons of each option, including tax consequences, the impact of current estate laws and regulations, and how it aligns with your objectives.
5. Implement and Review
Work with your financial advisor and estate attorney to update your estate planning documents including beneficiary designations, wills, and trusts, then make it a point to review with your advisors every two or three years to ensure everything is still the way you want it.
Understanding Your Options
Now that you understand the process for updating your estate documents, let's take a look at some of the more common estate planning strategies used to ensure you understand what options you have available to you, and what those options mean.
One of the easiest ways to leave money to your grandkids is through direct inheritance of a retirement account whereby the transfer of your assets will be governed by the beneficiary designations listed on your accounts. This means you'll want to ensure your beneficiary designations for each of your retirement accounts are updated.
Beneficiary designations on retirement accounts such as a Roth IRA can be listed as either primary beneficiaries, meaning the money will pass to these individuals first, or contingent beneficiaries who will inherit the money should the primary beneficiaries pre-decease.
Here are some examples of accounts you can leave your grandkids through a beneficiary designation:
401(k) and Traditional IRAs
If your grandkids are listed as beneficiaries on your pre-tax IRA and/or 401(k), they will each be required to open an inherited traditional IRA into which their inherited portion will be deposited after your passing. The transfer will be exempt from income taxes (state inheritance taxes may apply); however, your beneficiaries will be required to take required minimum distributions (RMDs) from their inherited IRA each year, which would be taxed at their ordinary income rates.
The new rules for inherited traditional IRAs mean that grandchildren must generally withdraw the assets over a 10-year period, potentially leading to a big tax bill depending on their tax situation. As such, you'll want to carefully consider the tax implications of inherited IRAs for your grandchildren.
Roth IRAs
Similar to your pre-tax accounts, a Roth IRA will also transfer directly to your grandkids by way of beneficiary designation; however, the funds would be deposited into an inherited Roth IRA which is an after-tax account. This means their RMDs are generally tax-free, making the Roth IRA a more tax-efficient option than 401(k)s and traditional IRAs for transferring money to your grandchildren.
Brokerage Accounts With Low-Basis Stock
A traditional investment account with stocks, funds, etc. that have significantly appreciated over the years can be an ideal option to consider giving to the next generation. That's because your beneficiaries will get what's called a step-up in basis in the value of your holdings, thereby reducing their capital gains tax going forward should they decide to sell.
Brokerage accounts work differently than IRAs and 401(k)s in that your will, or transfer-on-death (TOD) designation, will govern who inherits the assets rather than a beneficiary designation.
529 College Savings Plans
If you'd rather not have your grandkids inherit money directly and have it go towards their education, a 529 plan may be something to consider.
Similar to traditional IRAs, a 529 plan is an investment account that will grow tax-free, with contributions being state-tax deductible and distributions being exempt from capital gains tax if the funds are used for your beneficiary's tuition, books, and other qualifying educational expenses.
In addition to their tax benefits, 529 plans are flexible and allow you to change the beneficiary to another grandchild if the original beneficiary doesn’t need the funds.
Custodial Accounts (UGMA/UTMA)
Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) are like 529 plans but without as many restrictions. They allow you to contribute, or transfer assets to a minor while you remain in charge of the account until your grandchild reaches adulthood.
The accounts are titled in your name, with your grandchild listed as the primary beneficiary to receive the money when they reach the age of majority (usually 18 or 21, depending on the state).
While UGMAs and UTMAs generally have fewer restrictions than 529 plans (i.e. no stipulations for educational expenses), there may be income tax implications for unearned income from the investments that would be taxed at your tax rate. Additionally, the beneficiary will have full access to the money at a fairly young age which is something you'll want to consider.
Advanced Planning - Trusts
In addition to passing retirement savings, investment accounts and college savings plans through beneficiary designation, you may also want to consider more advanced planning techniques for transferring assets to your grandkids.
A trust is a legal document that provides flexibility and control over how and when your grandchildren receive their inheritance.
Trusts generally benefit high net-worth investors with assets nearing the estate tax exemption limit, families with special needs beneficiaries, or those who simply want more control over how and when their assets are distributed upon their death.
In general, there are two ways to structure a trust: revocable and irrevocable.
Revocable Trusts: These trusts allow you to control the distribution of assets and can provide detailed instructions on how and when your grandchildren will receive their inheritance.
Irrevocable Trusts: Once established, these trusts cannot be altered. They offer strong protection against creditors and may help reduce estate taxes.
If you'd like a more in-depth look at trusts, I discuss this topic in further detail here.
For those interested in establishing a trust, the process of establishing one looks like this:
Establish the Trust Document: Work with an estate planning attorney to create the trust document. This will outline the terms, including how the assets should be managed and distributed.
Fund the Trust: Transfer assets into the trust. This can include cash, investments, or even real estate.
Appoint a Trustee: Select a reliable trustee to manage the trust. This can be a family member, friend, or professional trustee.
Specify Distribution Terms: Clearly state how and when your grandchildren will receive their inheritance. You might choose to distribute funds at certain ages or for specific purposes, like education or buying a home.
Tax Considerations and Tax Implications
Like with anything related to money and investments, taxes play a significant role in updating your estate plan. Here are some key points to consider when working with your tax professional:
Be Mindful of the Annual Gift Tax Exclusion: The annual gift tax exclusion allows you to give up to a certain amount per year per recipient without having to file a gift tax return and being subject to the lifetime exemption (discussed below). As of 2024, the limit is $18,000 per person. That means if you have 10 grandchildren, you could give a total of $180,000 permitting you limit each gift to $18,000.
Lifetime Exemption: In addition to annual exclusions, there’s a lifetime estate and gift tax exemption of $13.61 million for individuals, double that for couples as of 2024. Gifts above the annual exclusion amount count toward this lifetime limit which, if exceeded, could result in a big tax bill for your estate.
Estate Taxes: While only applicable to large estates exceeding the exemption limits noted above, estate taxes need to be considered when crafting your estate plan. An irrevocable trust can be a great tool to mitigate this tax burden.
Income Taxes: Non-spouse beneficiaries, including grandchildren, must withdraw all funds from an inherited IRA within 10 years of the original owner’s death and pay ordinary income taxes on the distributions. Be certain you account for this when updating your beneficiary designations.
Regularly Review Your Plan and Communicate With Your Family
It's very easy to get so caught up in the minutia of planning and strategizing the best, most tax-efficient way to give money to your grandkids that you forget about informing them about your intentions.
Transparent communication with your family is essential. Discuss your plans with your children and grandchildren to ensure they understand your goals and the steps you’ve taken. This can help prevent misunderstandings and ensure that your wishes are respected.
Life circumstances and tax laws can change, so it’s important to review and update your estate plan regularly. I generally recommend doing so at least once every two to three years to ensure that your beneficiary designations are current, your trust documents reflect your directives and your strategies are still aligned with your goals.
Conclusion
Leaving your retirement savings to your grandchildren is a thoughtful way to support their future and create a lasting legacy. By understanding your options, strategically planning, and consulting with professionals, you can safeguard that your hard-earned savings are passed on efficiently and effectively. Regularly reviewing your plan and communicating with your family will help ensure that your wishes are honored and your grandchildren benefit from your generosity.
With careful planning and execution, you can leave a meaningful and impactful inheritance that supports your grandchildren's dreams and provides them with a solid foundation for the future.
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