How to Leave an Inheritance for Your Children

Whether they’re toddlers or mature adults, there are many ways to provide for your children after you’re gone ? without subjecting them to the burden of having to pay substantial taxes on their inheritance. This article reviews some of the tax strategies you can employ to ensure that your children are taken care of and to help minimize the impact of estate and inheritance taxes.

Trust Account

One of the most effective ways to secure an inheritance for your children to set up an Irrevocable Life Insurance Trust into which the proceeds of your life insurance policy will be deposited when you pass away. This type of trust is especially useful if you are remarried and have children from a previous marriage or relationship that you want to provide for. Your life insurance premiums will be paid out of the trust account, and you can stipulate how and when the death benefit proceeds will be distributed to your children.

For Example: You may want to assert that the trust proceeds be used primarily for college education, and that the trust payouts be distributed to your children at various ages (such as at 18, 25 and 30).  This prevents an immature or irresponsible child from coming into a large inheritance and spending the money frivolously, or being taken advantage of by others.  It also keeps the life insurance proceeds separate from your other assets, so that you/your beneficiaries can avoid paying estate or inheritance taxes on those proceeds.  If an inheritance tax does apply, the rate assessed by your state will likely be lower for your children (than other heirs or beneficiaries) because they are your direct descendants.

Gift Tax Exemption

Another way to direct funds to your children and reduce estate and inheritance taxes is to make a tax-exempt ‘gift’ to each child ? up to $13,000 per recipient per year (or $26,000 for married couples).  The problem with this method is that many parents do not believe their children are mature enough to handle large sums of money.  A possible solution is to set up a Uniform Transfers to Minors Act (UTMA) Account, for which the parent/guardian is named as the custodian of the account until the minor child reaches the state’s legal age of adulthood (typically 18 or 21).

Roth IRA

Another option for managing potential estate and inheritance taxes is to designate your children as beneficiaries on your Roth IRA. Since funds are contributed to a Roth IRA in after-tax dollars, the Roth IRA is a convenient way to avoid probate and leave your children the entire proceeds of your Roth IRA savings when you die. A Roth IRA does not need to be mentioned in your will or living trust, because the beneficiary form already shows the amount you allocated to each child. After you pass away, your children must present a copy of your death certificate (to the financial institution serving as the Roth IRA custodian) in order to claim their share of funds. Many people are taking advantage of the 2010 opportunity to convert Traditional IRAs to Roth IRAs to minimize the impact of estate and inheritance taxes for their heirs.

Trust accounts, cash gifts, Roth IRA beneficiary designation, and custodial accounts are all options to consider if you’re concerned with transferring assets to your children. It’s also recommended that you seek the services of a professional estate planner, who can work with you to reduce the burden of estate and inheritance taxes on your children.

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