“We want to make sure that our daughter’s share of the inheritance stays with her.” You don’t need to feel awkward about having this conversation. It’s perfectly normal to have this goal even if you do like your son-in-law. While I believe that my wife’s dad likes me (except for my inability to fix things around the house), I would bet that even he has this goal.
When you receive an inheritance, it is typically considered separate property. That is, it belongs to your daughter, not your daughter and her husband. Estate laws are state-specific, and you should be sure to talk to an estate attorney in your state before taking any specific action. The issue comes about when you commingle, and just like mingling, people like commingling. When your daughter inherits that money at Fidelity and she already has a joint account at Fidelity, it’s easier just to mix the two. It’s the account they’ll use to pay for the renovation and the unexpected expenses for the kids. Just like that, you may have converted at least part of the inheritance into marital property. The answer: a trust. The second question: What kind of trust? Here are three types of trusts that may make sense.
Testamentary Trust
Most people tout the main benefit of a trust as being probate avoidance. A testamentary trust will not help you there as it is created at death, via the will, which will be probated. The main benefit to this trust and most others is actually control.
You get to say who gets what, when, and how. There is a trustee who must act as a fiduciary and follow the terms of the trust, which will likely keep the money with your daughter. This language is easy to add to your will and, because it is funded at death, it does not create a lot of upfront work.
Revocable Living Trust
This is the vehicle most frequently used by our clients, but once again, it is not always necessary if avoiding probate is your only goal. A revocable trust is attached to your Social Security number, so there is no tax angle here. This is a vehicle meant to help your beneficiaries avoid probate and for you to retain some sort of control. Like a testamentary trust, it enables you to state very specifically what you want to happen with the money.
These are not typically complex vehicles, but they do take more upfront work than a testamentary trust. This will be a separate document or separate documents that are completed alongside your will. The challenge most people seem to have is actually funding the trust. You will have to change titling on bank accounts, homes and taxable investment accounts. Depending on your estate plan, beneficiary designations on retirement accounts and life insurance policies may also need to be reviewed. Just make sure if you open this pint of ice cream, you are willing to go all the way, and finish it. Unlike gorging on the ice cream, you’ll feel good once you do.
Irrevocable Trust
This is really an umbrella hanging over all sorts of different trusts that have their own tax ID numbers, and, thus, sit outside of your estate. Like the testamentary trust, they give you control. Like the revocable trust, they avoid probate. Unlike both previous options, they are often set up to help mitigate estate taxes.
So, if your goal is to make sure that inheritance stays with your blood line, the main reason to elect an irrevocable trust over a revocable one would be that your estate will be taxable at either the federal and/or state level. How do you find that out? We rely on our planning software to project out income, expenses, assets and liabilities to see what’s left at the end of the client’s life. If it looks like it will be close, we will tie in an estate attorney capable of handling this complex work.
The main reason estate plans fail is because folks have ideas but don’t have conversations. Maybe they do make it to the conversation, but they don’t make it to the action stage. Estate planning is like home maintenance. You can replace the roof before it starts to leak, or you can let it leak and replace the roof and whatever else it leaked on. I recommend the former.
This article is provided for informational and educational purposes only and should not be construed as investment, tax, or legal advice, or as a recommendation regarding any particular strategy. Whether a Roth conversion is appropriate depends on an individual’s financial circumstances, tax situation, investment objectives, and applicable law. Tax laws are subject to change and their application may vary. Examples discussed are hypothetical and are intended solely to illustrate general planning concepts. They do not reflect the experience of any specific client or guarantee future results. Consult your financial, tax, and legal advisors before implementing any strategy.