When to Give Inheritance Money to Your Kid?

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Estate planning is on my mind. Our big financial goal for 2021 was to get our estate planning done. We first reached out to an attorney in February 2020, but then there was a pandemic and we put everything off. In October 2021, I emailed the paralegal back, “I know it’s been 18 months since you sent us this email, but you know, COVID. We’re back! Can we still get an appointment?”

So, I guess the first lesson you should learn from this post is that whatever you’ve been putting off—an estate plan, refinancing your student loans, doing that rollover, completing your Backdoor Roth IRA, buying insurance, or deciding on an asset allocation—just do it!

Aside from overcoming inertia and general busyness, the other reason we put off the estate planning for a few months was that we were having trouble deciding exactly what that estate plan should look like. Before you go to see the estate planning attorney, you actually need to decide what you want to happen to your kids, your money, and your stuff when you die—especially if you die early. Once you know what you want to do, the attorney’s job is relatively easy. If you have no idea, you might waste a lot of billable hours trying to decide.

3 Big Decisions About the Inheritance

There are three big decisions we, and everyone else who wants to leave an inheritance, will need to make. The best estate plans provide the most flexibility on these issues, but the better an idea you have about these three big decisions, the easier the process will be. Naturally, the longer you live, the more finely you can tune this, but since you never know if you will die an untimely death, you will need to make these decisions earlier than you would like. There are no right answers to any of these three questions; only the right answer for you.

#1 How Much Inheritance Money to Leave to Your Children

The first big decision is relatively simple: “How much do you want to leave behind to your kids?” For most people, this is really easy: they want to leave everything behind that they did not need themselves. This is a very simple proposition if your estate size is less than the federal tax exemption ($12.92 million per person in 2023) (along with any applicable state estate tax exemption amount) and if no inheritance taxes will apply. You just need a will and, if you want to avoid probate, a revocable trust.

If you have more than one child, you will also need to decide how much goes to each of them. While the most common thing to do is to simply divide the estate by the number of kids, there are plenty of families that do not do this. They leave less to some kids than others, due to need or due to the decisions their offspring have made during their lives.

If your estate size is more than federal and state estate tax exemption amounts, this is where the attorneys can really earn their fees. Since you are trying to leave as much as possible, that means reducing your estate tax, inheritance tax, and income tax as much as possible. There are lots and lots of techniques you can put in place to do this.

However, there are many people, including us, who do not want to leave our children the maximum possible amount. In fact, we plan to leave more to charity than to our children. We wrestled with how much we really wanted to leave them. This was particularly important in the fall of 2021 when Congress was discussing reducing the estate tax exemption amount. If we wanted to leave them more than the estate tax exemption amount, we would need to implement a fairly complex plan to take advantage of the temporarily higher estate tax amount.

In the end, we decided to leave no more than even the new, lower estate tax amount. We subscribe to Warren Buffett’s theory on inheritances—we want to leave enough money that our kids can do anything they want, but not so much that they can do nothing. That amount might be different for everyone, but in our view, it was less than the estate tax exemption divided by four. Besides, if we don’t die an untimely death, we can always arrange for them to have more via gifting into irrevocable trusts.

One of the best parts of leaving less than the estate tax exemption amount to anyone but charity is that it can dramatically simplify estate planning. Of course, keeping the option to give more later (especially if the exemption amount goes down) means you end up with the complex plan anyway.

#2 When to Give Inheritance Money to Your Kids

The next big question we needed to answer was when we wanted our kids to receive the money. If we live a long time, we can decide this as we go along depending on how ready they are to take care of it. In fact, if we live a long time, they probably will not get most of their inheritance until we are gone. However, an estate plan has to take an untimely death or two into account.

We decided a long time ago that an inheritance is far more useful in your 20s than in your 60s, but we are also very well aware that dumping a bunch of money on a 20-something is a great way to ruin their life. We decided that they would not get most of their inheritance in their 20s but that they would get some of it. That inheritance comes in the form of three accounts:

1. 529 Account: To pay for their education
2. Roth IRA: Where we put their WCI-related salaries and match their earnings
3. UTMA Account: The 20s fund, to pay for all of those things we would use the money for in our 20s if we actually had any money: college, grad school, study abroad, summer in Europe, missions, weddings, honeymoons, cars, down payments, etc.

Beyond that money for their 20s, we don’t want our kids to have access to large amounts of cash for decades. While it will be easier to determine when they are ready for it if we live a long time, we had to figure out when we want them to get their inheritance if we keel over tomorrow.

We decided we did not want them to have it all at once. That way, if they screw up the first one they receive, they will eventually receive some additional boluses. Honestly, we do not view this as money for them to use. If bad things happen to them in their lives, they will have that option. But we hope that by the time they get most of this money, they will have already made it on their own and will view themselves as stewards of this money for the next generation. We decided to give them 1/3 of the money at 40, 1/3 at 50, and 1/3 at 60, keeping it invested in a trust on their behalf in the meantime. They will also have the option to leave it in the trust until they want it, providing significant asset protection for them.

#3 How to Control How Heirs Spend Your Money. Do You Want Restrictions? 

Many people put plenty of restrictions on the money to encourage their children to live their lives in the way the parents would prefer. You have to balance that with the unintended consequences of ruling from the grave. We decided we didn’t want to put too many restrictions on the money, but we did want to make sure they prove themselves financially literate before getting that first bolus of money. I thought about writing a financial literacy test they would have to pass to get it (and still may if I'm alive when they hit those ages). But for the trust, the requirement is to pass a financial literacy course chosen by the trustee such as this one put on by our alma mater. 

You may decide these questions completely differently than we did. That’s perfectly fine. Just like a financial plan should be personal, so should an estate plan. However, you will need to make these decisions to have an estate plan worth anything at all.

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