Passing on the family fortune

For years, you’ve worked hard, saved money and invested wisely. A comfortable retirement awaits, and there’s also some leftover cash for the children.

But while some parents may think it wise to hold on to the family fortune ’til death, financial planners say there are big tax advantages in gifting the money to heirs earlier. And there are ways to do it without the worry of spoiling the children.

Death and taxes
Even after death, the taxman comes calling. In 2006, anything more than a $2 million estate transferred is taxed at a rate of 46 percent. That means if your estate is worth $3 million, $1 million is taxed and $460,000 goes to Uncle Sam.

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Estate taxes used to be even higher before President Bush’s Estate Tax Relief Act of 2002, said Robert Pyle with Diversified Asset Management Inc. in Boulder. The new legislation has been decreasing the tax rate and increasing the tax-exempt amount – from a 50 percent rate and $1 million tax-exempt amount in 2002, to a 45 percent rate and $3.5 million tax-exempt amount in 2009. The estate tax is completely eliminated in 2010, but can return in 2011, if Congress does not extend the legislation, he said.

In order to reduce an heir’s estate tax burden, Pyle suggests that parents should gradually reduce their estate by gifting the money tax-free to their children and grandchildren soon after retiring.

In 2006, the government allows each parent to gift up to $12,000 to each beneficiary (related or not) tax-free. This means dad can gift $12,000 to a child and so can mom, for a total gift of $24,000. They can repeat that with as many beneficiaries as they please. If the parents have three children, they can reduce their estate by as much as $72,000 a year.

Gift options
Of course, handing over that much cash to children may not be comforting for most parents. There is a worry of spoiling their children too early. So Pyle recommends transferring most of the money to the child’s retirement accounts such as Roth IRAs and 401(k) plans. Here, the money is protected by penalty from early withdrawal. An added bonus is the tax-free and tax-deferred savings in the growth of these accounts. The maximum contribution to a Roth IRA is $4,000 a year. 401(k) Plans have a limit of $15,000 a year.

“Right there, you have $19,000 that’s protected for the child’s retirement,” Pyle said.

If grandchildren are involved, a College 529 Plan contribution may be a good option, said Rick Disberger, vice president of investments for Elevation Investment Group of Raymond James & Associates Inc. in Boulder. The plans allow families to save and invest money tax-free for a child’s future college costs. Grandparents can also set up Roth IRAs and other savings accounts in their grandchildren’s names.

“In some cases the child or grandchild may not even know about it until later on in life,” Disberger said.
The earlier these accounts are set up for children or grandchildren the better, Disberger said. The compounding effect (of the money growing at a faster rate off its reinvested profits) continues to be greater each year of the account’s existence.

Another gift route parents can consider is real estate. They can help their children make down payments on a new home.

If parents do want to gift straight cash to their children, then Disberger suggests setting up a checking account where the parents receive the statements. That way they can keep track of where the money is being spent.
Financial education

Especially if children aren’t used to handling larger amounts of money, both Disberger and Pyle recommend that some sort of financial education accompany the money. This could include teachings from the parent, or having the child meet with a financial adviser.

“Our school system doesn’t teach financial education to children,” Disberger said. “It’s one of those things where the parents need to get the investment education themselves (through reading and financial advisers) and then teach it to their children.”

Pyle cautioned against investment scams, which frequently are advertised as promising high returns.
“Stay away from so-called hot investments,” Pyle said. “If it sounds too good to be true, then it probably is.”

Contact David Clucas at 303-440-4950 or e-mail dclucas@bcbr.com.