Parents are masterful at assessing the potential consequences associated with giving a gift. Gifting your child a baseball bat increases the likelihood of a broken window, gifting a child a drum set decreases the possibility of a quiet night at home, and gifting a puppy means, well, now you have a puppy to care for in addition to your already-existing parental duties.
The immediate consequences of a birthday gift may be apparent, but the potential consequences of an estate or trust gift may not be as apparent. And, unlike the consequences a gift giver may experience as a result of a poor gift choice, the consequences associated with a wealth transfer affect the recipient. Here are some things to consider in order to minimize the consequences associated with a wealth transfer.
1. Have a Plan
This is the most obvious—and most important—step in any effort to remove unexpected surprises during a wealth transfer. The nature of assets, both value, and volume, will have an impact on the plan you choose. The simplest way to transfer wealth is simply to name beneficiaries in your estate and in the time of transfer, the assets just go to the beneficiary. A trust can make transferring wealth to the next generation simple and avoid probate (an unintended consequence of a gift). If you have complex wishes, a desire for charitable giving, or if a beneficiary can’t be trusted with a lump sum distribution, a trust makes a great deal of sense because it can involve an objective third-party administrator.
2. Name an Executor for Your Physical Assets
Choosing an individual to execute your wishes in your absence is an important decision. Make sure the individual you choose exhibits a basic understanding of finances and exhibits financial discipline in their own lives. When naming an executor, it is important to consider the mental and time strain placed on the individual (another unintended consequence). Executing even a simple estate plan can take up to six months and may require multiple meetings with tax professionals and family members. If the individual selected as an executor does not live in the same city as the estate, it may require multiple trips to the estate city, which results in unintended additional expenses and loss of time for the executor.
3. If You Are Transferring Real Estate, Make Sure the Title Transfers Properly
For most members of the Greatest Generation, their main assets to transfer to the next generation are retirement savings and their home. Transferring real estate can have potential pitfalls if not handled adequately. There are a few options for transferring real estate, including adding your beneficiary as a joint owner to the property while you are still alive. If the family member is added as a 50% owner with no additional considerations, and the value of their ownership portion exceeds the $16,000 annual gifting limit, you will need to file a gifting tax return via Form 709. Gifting real estate via a trust is perhaps the simplest way but it is important to remember that the beneficiary of the real estate transfer becomes responsible for any remaining balance on the property. Make sure that your trust accounts for any unpaid liens on the property prior to transferring ownership.
4. Have A Tax Plan in Place
Many people forget to account for their final tax bill when they build their estate plan. This can leave your executor holding the tax bill. For example, if an individual passes in February, taxes for that estate may not be able to be filed until the following year. If all of the assets in the estate are dispersed in the year prior to filing, someone will have to account for that final tax return. In general, it may be more tax efficient to spread asset distributions over a longer period or delay distribution to prevent a large influx of income that will be taxed. The world of taxes changes regularly. For example, when it comes to transferring IRA assets, the IRS requires that all funds be distributed within 10 years. Previous rules allowed those distributions to be spread of the life of the beneficiary to create some tax efficiencies.
Understanding the nuances of transferring wealth to a beneficiary is essential to ensuring that the funds you worked hard to earn and transfer make it to the people or charities you intended them to. To make sure that you and your beneficiaries pay their fair share of taxes and not a penny more! Make sure you have the appropriate team in place to help you plan for your estate. We recommend a trusted tax advisor, a legal representative, and a financial planner. If you feel out of step with any of the steps above, reach out and let’s get you on the right financial path!
By Kirk Pearson