Passing money to heirs involves many options

Many people spend time worrying about what will happen to their money when they pass on and the money moves to their heirs: Should I put it be in a trust, go through probate in the estate or something else? Should all my children be names as beneficiaries on retirement accounts? Should I give the money as gifts before I die?

I want to discuss a few of the options available to help make the conversation with your adviser, accountant or attorney a little easier.

One option for gifting or transferring money is to give individual stocks to your heirs. Individuals who may be holding on to appreciated holdings such as stocks could “gift” those assets to their younger heirs whether it be niece, nephew, son, daughter or grandchild.

In 2018, each parent could gift up to $15,000 each to their child. The tax imposed on the transfer of assets depends on the receiving heir’s income. However, “kiddie tax” places a tax burden on individuals under the age of 19 or full-time students under age 24. Earnings of more than $2,100 will be taxed at the rates that apply to trusts and estates, ranging from 10 percent to 37 percent.

An additional option is to start funding the heir’s retirement, if that person has earned income. For young adults with low earned income, a Roth IRA makes sense in most cases since these young adults are paying low to no tax on their earnings now and the funds will be tax-free in retirement when they will presumably be in a higher tax bracket. Roth IRA’s grow tax-free, as well, so there will be no annual tax burden for the heirs.

In this situation, the Saver’s Credit may be available. It reduces the income of an individual based on his or her earned income and the amount contributed to a retirement account. Once the heir holds the Roth IRA for five years, tax-free withdrawals can be made up to the amount of his or her contributions, but there will be tax on the earnings when the owner is under age 59 1/2.

You should also take into consideration who gets which accounts and assets. Often, it makes the most sense to leave tax-deferred retirement accounts to younger heirs since, as mentioned above, they will have to take an RMD and the younger heirs will most likely have lower tax brackets and longer time periods, reducing the amount of the withdrawal they are required to take.

When you gift appreciated stock while living, it should go to younger heirs in lower tax brackets, too, since your cost basis will be passed along. The opposite is true when the appreciated assets pass to your heirs after your death. The inherited stock will be valued based on the date of death of the owner. Your heir will pay capital gains tax based on that calculation on the date of death, not your original cost basis. This is commonly referred to as the “step-up basis.”

A trust account is another way to allocate your funds. There are different kinds of trusts which have different purposes. It is important to review your own individual situation to be sure a trust account is right for you. Generally, a trust is an arrangement for holding someone’s assets while they are managed by someone else (the trustee) on behalf of the beneficiaries. The trustee is held to the fiduciary standard, meaning the trustee must act in the best interest of the beneficiaries. Think of a trust as you would an escrow account. Just as a bank pays your property taxes and home insurance from the escrow account, a trustee distributes to a trust’s beneficiaries.

Trusts can be useful in estate planning. A living trust goes into effect while the creator is still living, and it usually gets to bypass the probate process. There are also revocable and irrevocable trusts which determine if the trust can be canceled or changed.

When considering end-of-life decisions, it can be a comfort to know not only that you can assist your heirs financially, but that you are going about it in the right way. For more information and to learn what may be best suited to your situation, consult with a financial adviser and/or attorney.

Brittany N. Cox is a registered investment adviser at Nestlerode and Loy Investment Advisors, State College.