How to leave inheritances to the grandkids for maximum tax efficiency

[Rylito]

My parents did their estate planning in 1999 so are now shopping around for lawyers to meet with to update their trust/wills/POAs, etc.

They met with one lawyer and realized while he could update their documents, he wasn't able to provide any advice regarding the most financially prudent way to designate their inhertances.  So I'm trying to help my parents come up with questions in advance to ask potential lawyers to narrow down the right type of estate planning for them.

One of the changes is that they have 2 grandkids, both in their teens.   Besides a paid-off house, my parents have Trad IRAs, 401(k)s, annuities, and a sizeable after-tax brokerage account.  After both of them pass, after leaving some money to charities they want to leave the rest of the first 4 assets to me and my siblings, and the brokerage account in a trust for the grandkids, split 50/50.  My parents will probably choose me or one of my siblings to be the trustee.  Each grandchild would get distributions of the principal from the brokerage account spread over time starting at age 25 at the earliest.  Parents live in a US state that has no state taxes, and their current net worth including their house is around 3 million.

Questions:

1.  Are there any particular advantages or disadvantages to leaving the Trad IRAs and 401ks to the adult children vs. the grandchildren, and the brokerage account to the grandchildren vs. the adult children?

2.  Does the trustee have to sell and re-buy the stocks in the brokerage account at the time of my last parent's death to establish a new basis?

3.  Assuming there is a gap between the time my last parent passes and the first grandkid turns 25, given the higher tax rate on trust income than personal income, would it make more sense to leave the brokerage account to the parents with the understanding that they would then give the money to their kids at age 25 and after?  (The siblings can be trusted to do the right thing in this situation.)

[secondcor521]

Not an expert; one will be along shortly to correct me I'm sure.

1.  The IRAs and 401(k)s will generally need to be completely emptied in 10 years and will be treated as ordinary income if traditional; not taxable if Roth.  Taxable accounts and house will receive step up in basis.  Strategically I think you want to consider the relative tax rates of the children and grandchildren in the 10 year window after your parents pass away - I would think it would make sense to leave the IRAs and 401(k)s to the grandkids and the taxable/house to the kids to the extent possible to maximize after tax value.

2.  No.  You just inform the brokerage firm that the assets in the account need to be stepped up in basis as of the date of death.  The step up works differently in community property states vs. separate property states, so make sure you understand the rules that apply to your parents.  There is generally a step up in basis at both deaths.

3.  Maybe.  You could also just try to talk your parents into leaving whatever assets they want to the grandkids directly.  If they're under the age of majority in their state when your parents pass away, then there will need to be a custodian (their parent(s) probably) anyway.  Age of majority is probably 21, which isn't too far off 25.  It's also a ton simpler to write up in the will and to administrate, and the taxes would almost certainly be lower than a trust.  More flexible too if the kid happens to be finishing college or going to grad school in that time frame.

As a side note:  I'm guessing your parents have two kids, each with one grandkid.  If they do have a trust for the grandkids, they might as well create two separate and equal trusts, one for each grandkid, with their parent as the trustee.  It would just seem to minimize risk of bad blood happening between the two families as a result of misunderstanding, miscommunication, different opinions, etc. about the trusts, their contents, and the administration over the kids' lifetimes.

[Raenia]

As a side note:  I'm guessing your parents have two kids, each with one grandkid.  If they do have a trust for the grandkids, they might as well create two separate and equal trusts, one for each grandkid, with their parent as the trustee.  It would just seem to minimize risk of bad blood happening between the two families as a result of misunderstanding, miscommunication, different opinions, etc. about the trusts, their contents, and the administration over the kids' lifetimes.

Just to comment on this, the way our trust document is written is that when the youngest heir turns 18, the trust is split into separate, equal trusts for each heir, which then pay out on a schedule based on that heir's age. Might not be their preference if there is a big age gap between grandkids, but it does take care of the fairness issues.

Pretty academic for us, as we only have one kid at the moment, but this seemed to be our lawyer's standard language for future-proofing the wills.

[secondcor521]

As a side note:  I'm guessing your parents have two kids, each with one grandkid.  If they do have a trust for the grandkids, they might as well create two separate and equal trusts, one for each grandkid, with their parent as the trustee.  It would just seem to minimize risk of bad blood happening between the two families as a result of misunderstanding, miscommunication, different opinions, etc. about the trusts, their contents, and the administration over the kids' lifetimes.

Just to comment on this, the way our trust document is written is that when the youngest heir turns 18, the trust is split into separate, equal trusts for each heir, which then pay out on a schedule based on that heir's age. Might not be their preference if there is a big age gap between grandkids, but it does take care of the fairness issues.

Pretty academic for us, as we only have one kid at the moment, but this seemed to be our lawyer's standard language for future-proofing the wills.

My point was that if there's one trust and *one trustee*, that one trustee (from the way I read the OP anyway) would be managing and distributing the trust for his/her kid and his/her nephew/niece.  It is easy for me to see ways that the nephew/niece's parents might not agree with the way the trustee is doing things, and if there's significant money involved (or even if not) that could cause a family rift.

[Raenia]

As a side note:  I'm guessing your parents have two kids, each with one grandkid.  If they do have a trust for the grandkids, they might as well create two separate and equal trusts, one for each grandkid, with their parent as the trustee.  It would just seem to minimize risk of bad blood happening between the two families as a result of misunderstanding, miscommunication, different opinions, etc. about the trusts, their contents, and the administration over the kids' lifetimes.

Just to comment on this, the way our trust document is written is that when the youngest heir turns 18, the trust is split into separate, equal trusts for each heir, which then pay out on a schedule based on that heir's age. Might not be their preference if there is a big age gap between grandkids, but it does take care of the fairness issues.

Pretty academic for us, as we only have one kid at the moment, but this seemed to be our lawyer's standard language for future-proofing the wills.

My point was that if there's one trust and *one trustee*, that one trustee (from the way I read the OP anyway) would be managing and distributing the trust for his/her kid and his/her nephew/niece.  It is easy for me to see ways that the nephew/niece's parents might not agree with the way the trustee is doing things, and if there's significant money involved (or even if not) that could cause a family rift.

I was agreeing with you, and just including additional details.

[secondcor521]

As a side note:  I'm guessing your parents have two kids, each with one grandkid.  If they do have a trust for the grandkids, they might as well create two separate and equal trusts, one for each grandkid, with their parent as the trustee.  It would just seem to minimize risk of bad blood happening between the two families as a result of misunderstanding, miscommunication, different opinions, etc. about the trusts, their contents, and the administration over the kids' lifetimes.

Just to comment on this, the way our trust document is written is that when the youngest heir turns 18, the trust is split into separate, equal trusts for each heir, which then pay out on a schedule based on that heir's age. Might not be their preference if there is a big age gap between grandkids, but it does take care of the fairness issues.

Pretty academic for us, as we only have one kid at the moment, but this seemed to be our lawyer's standard language for future-proofing the wills.

My point was that if there's one trust and *one trustee*, that one trustee (from the way I read the OP anyway) would be managing and distributing the trust for his/her kid and his/her nephew/niece.  It is easy for me to see ways that the nephew/niece's parents might not agree with the way the trustee is doing things, and if there's significant money involved (or even if not) that could cause a family rift.

I was agreeing with you, and just including additional details.

Ah, OK.  :thumbsup: :)

[Dee18]

Your parents definitely need to work with an attorney familiar with both state and federal tax issues.  Money to be left to charity should be from the traditional IRA and/or 401(k) (as long as it is not a Roth 401(k)). Money from either of those left to individuals will be taxed as income, not capital gains.  The charities would pay no taxes and get to keep the entire bequests. 

Each of my parents set up a trust in the 1990s.  My father’s left his assets to his 2 children in equal parts, to be distributed upon my mother’s death with her able to use the income from the trust until her death.  My mother’s leaves hers to her 2 children and 1 grandchild in equal parts, with the caveat that if the grandchild is younger than 26 the child’s parent who is also an heir will be the guardian of the money until the child is 26, although the parent can use the money for the child for many things including education at any level, medical care, etc.  I think this is much better than having a trust that doles out the money.

My own will initially set up a trust for my child, doling out money beginning at age 26.  But I recently revoked that trust and am now leaving everything through beneficiary designations and transfer or pay on death designations. Beneficiary designations override a will or trust document.  And my now 28 year old “child” is responsible enough to inherit now. My parents’ trusts have not done nearly as well as my investments…largely because my father initially set them up with the money handled by a highly regarded investment company that (like many) invests in individual stocks which don’t do as well as index funds and, of course, takes a cut of the money in fees every year.  My mother and sibling have insisted on sticking with that company although my father died many years ago.  A key reason not to have a trust if it is not needed is that the trust has additional tax filing requirements.  Also in my parents’s home state the money cannot be released until at least 6 months after the death.  Beneficiary directives will instead be available immediately upon proof of a death certificate. 

As a former attorney I hate to say this, but keep in mind an attorney is going to make a lot more money getting people to set up trusts than by telling them to use beneficiary designations. 

All of the above assumes that your parents’ estate will not trigger federal or state estate taxes (8 states still have those).