Preparing heirs to inherit wealth can be a complex and emotional process, requiring open communication, gradual exposure, and much consideration. There are several tools that should be considered in your financial plan and portfolio when preparing heirs to inherit wealth.
First, having a comprehensive financial plan in place can provide a clear picture of your current and future cash flow. Once you have successfully met your financial needs, with proper planning, you can strategically invest and allocate assets continually securing your financial future and build a legacy for the next generation.
The following strategies are common tools utilized when considering wealth transfer to the next generation:
A step-up in cost basis is a significant tax benefit that can reduce capital gains taxes for heirs. When an asset is inherited, its cost basis is adjusted to its fair market value at the time of the decedent's death. This means when the heir eventually sells the asset, they will only pay capital gains tax on the appreciation that occurred after the inheritance. For example, if you purchased Apple stock for $100,000, and it is now worth $200,000, you would have a $100,000 unrealized capital gain. If you were to sell this stock, you would pay capital gains tax on the appreciation ($100,000). However, when your heirs inherit the Apple stock, their cost basis becomes $200,000, and they can sell the stock without paying a capital gains tax. This provides a way to reduce taxes during your lifetime and create a tax-advantaged wealth transfer for your heirs.
When considering your estate plan, it is important to work with your Financial Planner identifying opportunities for Roth IRA conversions. When you convert IRA dollars to a Roth IRA, you are paying ordinary income tax on the dollar amount converted that year. When doing a Roth conversion, the idea is to identify opportunities to pay taxes today, with the goal of having your Roth earnings grow and accumulate tax-free. Unlike traditional IRAs, Roth IRAs do not have mandatory required minimum distributions (RMD’s) at age 73 or 75. This means you can let your retirement savings continue to grow and compound over time, potentially leaving a larger, tax-free legacy for your heirs. From an estate planning standpoint, Roth IRAs can be a valuable tool since you already paid the taxes during your lifetime enabling the beneficiaries to inherit the account and avoid income taxes on the distribution.
Aggressive investment strategies, such as investing in a diversified portfolio of US and non-US equities can potentially generate significant returns over the long term. Equally as important to the diversification of a portfolio is the placement of assets within the portfolio. For example, a Roth IRA is a type of account funded with after-tax dollars. This means any money invested inside this account was already taxed. Future growth in the account is tax-exempt and withdrawals from the account are tax free after age 59 ½. When inherited, Roth IRA distributions are tax free to the beneficiaries. Given the tax advantaged nature of this account, you typically want to hold the most aggressive, growth-oriented asset classes of your portfolio inside of a Roth IRA, such as small cap funds and non-US stocks.
Gifting appreciated assets during your lifetime allows you to transfer wealth and reduce your taxable estate. Be mindful of gift tax rules and annual gift tax exclusions. Gifting up to the annual exclusion limit ($18,000 in 2024) per recipient per year is tax-free. Gifting larger amounts can utilize your lifetime exemption, which is currently $13.61 million per individual.
Leveraging trusts in estate planning can be a powerful strategy to protect assets, manage wealth distribution, and minimize tax burdens. Trusts provide protection against creditors and protection for beneficiaries.
Trusts are structured to safeguard assets from beneficiaries who may be financially irresponsible or vulnerable. Trusts also provide flexibility in how and when assets are distributed to beneficiaries, allowing for customized plans based on individual needs and circumstances.
There are numerous types of Trusts, but two of the most common are Revocable and Irrevocable Trusts. A Revocable Trust can be modified or terminated by the grantor during their lifetime. An Irrevocable Trust cannot be changed or revoked after it is created.
It is important to work with your financial planner to develop a comprehensive plan minimizing taxes and maximizing the benefits for you and your heirs. Consider asking your financial planner to engage your heirs in open discussions on financial matters, values, and expectations.
As tax laws and your financial situation change, reviewing and updating your asset allocation accordingly is prudent.
Understanding the decisions you should consider within your financial plan and portfolio will preserve the wealth for the next generation. By implementing effective wealth transfer strategies, you can significantly reduce your heirs' tax burden and help ensure the long-term preservation of assets to the next generation. As Apella Wealth advisors, we are here to help and take out the complication of generational wealth transfer.
Disclosures:
Apella Capital, LLC (“Apella”), DBA Apella Wealth is an investment advisory firm registered with the Securities and Exchange Commission. The firm only transacts business in states where it is properly registered or excluded or exempt from registration requirements. Registration with the SEC or any state securities authority does not imply a certain level of skill or training. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, product or any non-investment-related content made reference to directly or indirectly in this material will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may not be reflective of current opinions or positions. Please note the material is provided for educational and background use only. Diversification seeks to improve performance by spreading your investment dollars into various asset classes to add balance to your portfolio. Using this methodology, however, does not guarantee a profit or protection from loss in a declining market. Past performance does not guarantee future results. All data is from sources believed to be reliable but cannot be guaranteed or warranted.
No current or future client should assume that any discussion or information contained in this material serves as the receipt of, or as a substitute for, personalized investment advice. As with any investment strategy, there is the possibility of profitability as well as loss.
Apella Wealth does not provide insurance services or legal advice and nothing either stated or implied here should be inferred as providing such advice.