By Barry L. Kohler
Some aging Mainers adopt a “die broke” strategy. Others strive to pass assets to their children, grandchildren, or other heirs. Many find thinking about inheritance techniques to be confusing – and often an emotional burden – particularly when making decisions about who is to receive an inheritance.
With those challenges in mind, the key to successfully planning for an inheritance involves four important questions:
What do you want to pass on?
To whom do you want it to pass?
When do you want it to pass?
How to help protect the inheritance?
Regardless of the technique, once one decides to pass assets to the next generation, the discussion frequently turns to how to protect it from “creditors and predators.”
Let’s assume that the parent has done his or her own planning to protect the assets intended to be passed down. (There are special considerations if the parent is a business owner.) At a minimum, it means having adequate insurance, making sure your estate planning documents are current, and, as Grandma advised, not having all your eggs in one basket.
Determine what you want to pass on.
Inheritance planning begins with figuring out what you want to pass on. In Maine, many families have real estate assets, such as a family camp, summer cottage or even farmland. There may also be investments or “liquid” assets (such as cash, savings accounts, CDs, etc.). In thinking this issue through, don’t forget items of sentimental, rather than just financial, value. Who gets Dad’s favorite fishing pole or Mom’s favorite necklace may be even more important than what percentage does each child get of the bank accounts.
What an inheritance will “look like” depends upon a number of factors, including: a. the size of the potential inheritance; b. the number of potential inheritors; and c. the dynamics of your family. Many questions are guided by how the family has functioned. In your family, does fair always mean equal, or not necessarily? For example, in some families the goal is to provide an education to help the child earn a living. In other families, the same dollar amount is set aside for each child, whether she wants to be a rocket scientist or a cosmetologist. These are questions that a financial planner or an estate planner can help your family navigate.
Consider who will receive an inheritance.
Does it go to children, assuming (hoping?) they will treat their children fairly, or are some gifts made directly to the grandchildren? What about charity? Is some percentage (or a dollar amount) to go to your church or school or other organization about which you feel strongly? Does the inheritance go into the organization’s general fund or do you wish the money to be used for a specific purpose (for example, to start a girl’s curling team or for the repair and maintenance of the organ).
What if there are no family members? We heard of a very wealthy single person who left his fortune as follows: 25 percent to his church, 25 percent to his college, 50 percent to be divided among the members of his Thursday night bowling team.
Decide when to pass on the inheritance.
While there are some cases where children or other beneficiaries have special needs, the more common issue is what if an intended beneficiary does not have good money sense. It’s not uncommon for families to delay the distribution of the inheritance until the child is more mature and demonstrates responsibility. There are also alternatives to simply delaying the inheritance. Custodial accounts, simple trusts, and more complex strategies might be considered, depending on the circumstances. There is no “one size fits all” solution when it comes to planning an inheritance.
For many families, a prudent distribution plan often has some amount pass immediately on death, say 10 percent or 25 percent (or a specific dollar amount), and the balance distributed later, typically three or five years later or at a specified age or ages. Some choose to have the inheritance distributed in three installments, rather than two. For example, 20 percent immediately (almost regardless of the age of the beneficiary), one half of the balance in five years (or when the beneficiary attains a specified age, say 30), and the remainder five years later.
Consider how to protect the inheritance.
It is a small step from delaying distribution to considering how to protect the inheritance. Protect it from whom? Some families wish to protect the inherited assets from creditors and predators, or provide a measure of divorce protection. Others are more concerned about protecting the inheritor from his or her own lack of judgment or wisdom. Again, depending on the size of the inheritance and what we know today about the person who will receive the assets, there are a number of strategies to consider. Often a trust can be effective in helping to protect an inheritance.
Trusts come in a wide variety, each with multiple options: permanent or temporary, revocable or irrevocable, created during lifetime or upon death, etc. What all trusts have in common are three required elements: a beneficiary, assets and a trustee. It is the trustee who assures the funds are used as the trust-maker wishes, which can (and should) be specified in the document creating the trust.
It is terms of the trust and the trustee’s judgment that inject flexibility into the plan. This can give the trust-maker the option to “have her cake and eat it too.” Distribution can be delayed and the assets can still be made available for the use and benefit of the beneficiary … as determined by the trust-maker. For example, the funds might be held until age 35, but the trustee could be given the discretion to allow some (or even all) of the funds to be used earlier for education, medical needs, to buy a home or a business, travel, or any other purpose(s). It is the trustee who tries to act as the trust-maker would if he or she were available to “help” the beneficiary to make wise decisions.
The exact terms of the trust, who should serve as trustee, and when the trust should end are beyond the scope of this column. But they are critical aspects to be considered and discussed in trust planning.
In addition, insurance is another critical piece to help protect an inheritance, both before and after the inheritance has passed. A reasonable amount of property and casualty insurance is an essential step in protecting assets, especially automobile liability coverage and, if appropriate, umbrella coverage.
Are these strategies “bullet proof”? Unfortunately, no. It is usually not possible to absolutely protect assets from a divorce judgment or tax liability. However, as in so much of planning, to quote Voltaire, don’t let “perfect” be the enemy of “good.” Doing something is almost always better than doing nothing!
Barry Kohler is a senior vice president and senior planning adviser at Androscoggin Trust and Wealth Management. He is a Certified Financial Planner practitioner as well as a member of the Maine bar.