The earlier you begin to plan your child’s financial future, the better. However, an important question that arises is when do you start to implement, i.e., when do you give the inheritance money to your kids?
Of course, inheritance has evolved beyond “leaving an inheritance,” referring to when you pass away. You can begin the process of estate transference during your lifetime and as your kids get older.
All in all, there are a few factors to consider before making a decision. Let’s look at the best ways to leave money to a child.
Best ways to leave money to a child
Some of the most effective methods are:
- Wills: Leaving an inheritance after death is most commonly done through wills, and for good reason.
- Life Insurance: A life insurance policy is another way to leave some money to your kids after your passing.
- Trusts: Leaving money to children in a trust, revocable or irrevocable, is probably the most effective way to tie the money to milestones in your children’s lives, ensuring they have to be reasonably responsible to get the money, whether you are alive or dead.
- Gifts: Gifts from you to your children are things you give directly to them without expecting anything in return. They are also one of the most common ways of passing inheritance to children.
Next, let’s consider some factors to keep in mind before deciding when to give inheritance money to kids.
Children’s needs vs. your needs
This is one of the most important things to consider when deciding when to give inheritance money to your kids. The question here is how much your children need the money, and do you foresee yourself being able to maintain your lifestyle if you part with the money now? Suppose you’re a High Net Worth Individual (HNWI) with enough money to last lifetimes. In that case, there’s no rule against starting to set aside inheritance money for your children from the first year of their lives, as long as you properly consult with your advisors.
But if you aren’t, as much as you may want to support your kids, it is important not to do that to your detriment.
Generally, as your children grow older, their needs will likely increase while yours reduce. Therefore, you may give more inheritance money to meet your kid’s needs, like a mortgage, a car, or a business.
How does the time you give inheritance money to kids affect your taxes?
Worrying about how the time you give inheritance money to your kids affects your tax burden is also natural. But, it makes very little difference to your taxes if your estate is worth less than $12.92 million. The most common taxes that arise with inheritance distribution are gift taxes if you use gifts to distribute your kids’ inheritance. However, each person is entitled to annual exclusions. The effect of these exclusions is that your gifts will only be taxed when they exceed your annual and lifetime exclusions.
At the federal level, the annual exclusion for 2023 is $17,000. This means any gifts you give this year will not be taxed as long as the gift is not over $17,000. However, if you give jointly with a spouse, your limit for a year will be $34,000 for both of you. When you give over the limit in a year, you begin to use a portion of your estate tax exclusion, which stands at $12.92 million (or $25.84 million for couples) for 2023. Once you go over this estate tax exclusion (or lifetime gift exclusion), your gifts will be taxed for every year you go over the annual limit, and what is left of your estate will be taxed immediately after you pass away.
(Source: Nerd Wallet)
With this in mind, giving inheritance money now may be advantageous because estate exemptions are currently this high because of the Tax Cuts and Jobs Act of 2017. This Act will “sunset” by 2026 if the Senate does not extend it. By the time it sunsets, estate tax exemptions will return to between $6 and $7 million per individual.
Estate taxes at the state level differ, and you can read this article to learn more about them.
How does the time you give affect your health insurance?
When planning for healthcare costs in your old age, it’s always best to envisage rising costs. Even if you have insurance, knowing what your insurance does and does not cover is important. Original Medicare, for instance, does not cover everything. To be eligible for Medicaid as a nursing home resident, you must have no more than $2000 in countable assets (which might be higher in some states).
Giving inheritance money to kids to qualify for Medicaid is not always the best idea, especially since it can result in penalties. However, if it is an idea you’re willing to consider, ensure to properly consult advisors who can help you draw up a plan. Other long-term care insurance policies may sufficiently cover you after retirement but may also be expensive.
Preserving harmony in your family might be another factor affecting when to give your kids inheritance money. If your children believe that they are at an age where they deserve their inheritance money because they need it for other things, they may begin to make demands. Once you provide a portion or the whole of their inheritance money to one child, other children may start to feel entitled. If you refuse to grant other children the same, either because you don’t see their need or are financially unable to, it may lead to rifts in the family.
So just remember to consider on your family the impact of your decisions when you plan to give inheritance money to your kids.