Helping Clients Responsibly Leave Wealth to Grandchildren
Estate planning attorneys frequently hear from their clients, “I’d like to leave something to my grandchildren. What’s the best way to do that?”
Naturally, grandparents love their grandchildren and want them to succeed in life. And when grandparents are in the twilight of their lives, their hearts often turn to the younger generation with a desire to give them whatever advantages they can, especially if they were unable to give their own children those same advantages when their children were younger.
For most grandparents, the best way to provide for their grandchildren is to leave their accounts and property to the grandchildren’s parents to ensure the financial stability of that family unit, thereby indirectly benefiting the grandchildren. In fact, default inheritance laws in nearly every state reflect this common desire to provide first for children and then for the grandchildren in the event that an adult child predeceases the grandparent. From a practical perspective, the grandchildren’s parents are often in the best position to know how to use the money for the benefit of their children and can spend or invest it appropriately on their behalf.
In some cases, however, it makes better sense for grandparents to leave property directly to their grandchildren—for example, if the grandparents have reason to believe that their own children would not responsibly use the money intended for the benefit of the grandchildren, or if the grandchildren’s parents are independently wealthy and distributing the property to them would unnecessarily expose the property to estate tax in their estate. In other cases, although the intent of the grandparents may have been to leave everything to their adult children, an inheritance may flow to grandchildren unintentionally because of an accident or illness that prematurely takes the life of an adult child. In any of these situations, it is important to consider the possibilities and the options for leaving an inheritance to grandchildren. Failing to do so can have long-lasting consequences and, in many cases, do more harm than good.
Perhaps the simplest way for clients to leave an inheritance to grandchildren is to name the grandchildren as beneficiaries in their will or trust to receive a specific amount of money or a percentage of their total accounts and property. If all of the grandchildren who will receive such gifts are physically and emotionally stable, financially prudent, and have reached adulthood, this strategy may work just fine and reduce the administrative burden of distributing and managing your client’s accounts and property to their beneficiaries or heirs.
However, depending on when the client passes away, if any of the named grandchildren are minors, the client could create additional hassles by leaving a gift directly to their grandchildren. The executor of your client’s estate or the trustee of their trust may have to establish certain types of custodial accounts to hold that gift for the minor child until the child has reached the age of majority (either age eighteen or twenty-one depending on the state). In some states, and depending on how much money is involved, establishing a court-controlled conservatorship over the property may be required. In other cases, setting up an account using the Uniform Transfers to Minors Act laws of the state may be all that is necessary. In either of these cases, however, once the child reaches the age of majority, the client may not be able to control how that money is used by the grandchild. It could be spent on fast cars and fancy clothes rather than on an education, starting a business, or a down payment on a home, as your client might have imagined. In a worst-case scenario, a grandchild might even unwisely invest it with a spouse who later divorces them, or with an unscrupulous business partner who preys upon inexperienced individuals who have come into a sum of money.
By being aware of these risks, you can help your clients take steps today to make sure that any of their property that ends up in the hands of their grandchildren is protected from not only their grandchildren’s own poor spending choices but also the claims of a divorcing spouse, an unethical business partner, or an opportunistic lawsuit filed by a stranger against a grandchild.
A trust offers one of the most flexible methods for leaving an inheritance to grandchildren. When a client leaves an inheritance to grandchildren via a trust, they can ensure that the money and property are used appropriately and at appropriate times. There are a variety of ways to use trusts in estate planning. Clients can add provisions to their wills or revocable living trusts that instruct the executor or trustee to hold any property that is payable to a grandchild in a separate trust share rather than making a direct distribution of the accounts or property to them. Clients can specify in those trust terms how the money is to be used or distributed and when. These can be very important provisions to include in a trust even if the client is planning to leave their accounts and property only to their children. As mentioned, it is possible for a client’s child to pass away before the client does, such as in an accident or from illness. And if a client’s child has children of their own and the client wants their child’s share to go to their own children, it can be crucial to have a trustee protect and manage it until it can be distributed to the grandchildren at a more appropriate time.
Another way to use trusts is to create the trust during the client’s lifetime (an inter vivos trust), name the client as the trustee, and transfer some of the client’s property into the trust for the benefit of the grandchildren. From a tax perspective, a client can make gifts to this trust using the annual gift tax exemption (currently, $15,000 per beneficiary of the trust per year) to shelter the gifts from transfer taxes. Gifting in this way during life allows a client to have confidence that the trust is set up appropriately and enables them to enjoy watching their grandchildren actually benefit from the trust. They can also feel confident that once they pass away, their grandchildren and even their great-grandchildren will continue to benefit from the property in the trust, if that is their goal.
Beyond the traditional use of trusts in estate planning, clients can also design special trusts to provide additional tax benefits if their estates are large enough to potentially be subject to the generation-skipping transfer (GST) tax. A health and education exclusion trust (HEET) is one of these special types of trusts. A HEET is designed to make use of certain tax code provisions that exclude from lifetime gifts any amounts paid directly to healthcare and education institutions on behalf of someone. A HEET can be designed to name, as beneficiaries, any number of a client’s grandchildren or succeeding generations, if desired. The funds in the trust can then be used to pay for health and education expenses directly on behalf of the beneficiaries without being subjected to gift taxes in the future. Furthermore, the distributions to the beneficiaries will be exempt from the GST tax. This benefit is obtained by naming a charitable institution as an additional beneficiary of the trust. As long as the trustee makes regular and reasonably substantial distributions to the charitable beneficiary from the trust, the distributions to the other beneficiaries will be GST tax-exempt.
A HEET is worth considering if (1) the client would like to help their grandchildren and succeeding generations with their education and medical expenses, (2) the client has used up their GST tax exemption amount through gifting or other estate planning strategies, and (3) the client wants to benefit a charitable organization as part of their estate planning.
Although we have mentioned GST taxes in passing, it is important to remember that whenever a client is including grandchildren in their estate planning, they should seek advice from their attorney and tax advisors with regard to this unique form of taxation. For most people with modest accounts and property, the GST tax is not a significant issue. However, if what the client owns is valued at more than the current estate tax exemption amount, the GST tax is something that the client should be aware of and plan around, particularly if they anticipate that any amount of their property will eventually be distributed to their grandchildren. Clients should also be aware of the GST tax if they are creating trusts specifically for their grandchildren and their descendants. Clients may need to take certain steps upon creation of such trusts to ensure that the trust is GST tax-exempt. An experienced tax professional can provide you with important guidance on this point.
Grandparents often overlook bringing parents into the conversation when planning for their grandchildren. Consequently, some grandparents have been unpleasantly surprised at the negative reactions from their own children or in-laws when they make generous gifts to their grandchildren. Depending on a family’s parenting philosophy, the grandchildren’s parents may resent an unexpected, large sum of money or the payment for certain expenses. Instead of seeing it as a boon, a parent could see it as a grandparent interfering in the character development of their children, robbing them of important opportunities to become financially independent and learn important life lessons about sacrifice and hard work, such as qualifying for merit-based scholarships, and the value of money in general. Having your clients speak with the grandchildren’s parents beforehand about how they can best support their grandchildren’s development into responsible adults can go a long way toward ensuring that your clients’ gifts will be appreciated and truly beneficial in everyone’s perspective.
Whether your clients want to specifically and intentionally include their grandchildren in their estate planning or just want to make sure that their grandchildren are carefully accounted for in the event that their grandchildren unexpectedly inherit their property, it is critical that your clients examine their estate planning with their attorney to ensure that their plan reflects their wishes and overall family values. Beyond making sure that your clients’ property gets to the right people at the right time, careful planning with the help of competent tax professionals can also ensure that significant tax savings are preserved, thereby keeping more money in the hands of your clients’ families and out of the hands of the government.