“We all want to be remembered, and an inheritance creates another connection to your grandchildren, whether you’re giving money and a head start, or a prized collection of baseball cards,” Jeffrey Asher, an estate planning attorney working in New York and Connecticut told The Balance. To provide your grandchildren with an inheritance, consider how you want to create those memories—and plan your inheritance carefully. Learn about an inheritance’s promises and pitfalls, the best ways to leave money to grandchildren, and how to prepare your grandchildren for one.
What to Consider With Inheritances
One of the central issues for any inheritance is whether your estate could exceed the federal estate tax exclusions or be subject to state estate taxes. As of 2021, the federal estate tax exclusion for your total estate was $11.7 million per person. The exclusion increases to $12.06 million in 2022. It’s important to know that the exclusion amount may be temporary, because it was set by the 2017 Tax Cuts and Job Act and could revert to the previous limit of $5 million, adjusted for inflation, in 2026. New federal legislation could also lower the estate tax exclusion at any time. If the total gifts you give during your lifetime and your estate together are worth less than $11.7 million ($12.06 million in 2022) before 2026 are not subject to state estate taxes, minimizing estate taxes won’t be your central concern. However, you’ll still need to ensure that you’ve left clear legal instructions on assets and gifts intended for your grandchildren. Some states also charge estate and inheritance taxes for grandchildren who receive estate assets, no matter the estate’s size. For example, Pennsylvania charges a 4.5% tax on assets received by direct descendants and lineal heirs. Some states, such as Iowa, base inheritance taxes on the share of the estate or the right to receive the amount—and the recipient is responsible for the taxes—although property passed to a surviving spouse and lineal descendants, including children and grandchildren, is exempt. In other states, such as New Jersey, grandchildren may face an inheritance tax for amounts larger than $675,000. Due to these differences, consulting with an estate lawyer in your state is critical.
The Best Ways to Leave Money to Grandchildren
The best way to leave money to your grandchildren depends on your circumstances and the size of your estate, Asher said. There are a few different ways to go about leaving an inheritance to grandchildren.
Will
A will identifies the grandchildren you’re leaving assets to and your intended distribution of those assets. A will can be the instrument you use to divvy up your baseball-card collection or jewelry among grandchildren. However, a will alone doesn’t always provide for a trust’s specific financial instructions, probate avoidance, and taxes. You also might not be able to pass some property to minor grandchildren through a will alone and would need to consult with a lawyer for the proper strategy. If you don’t create a trust, any funds you leave to your grandchildren are overseen by the child’s parents or guardians until they turn 18 or adulthood (per state), then given to the child.
Trusts
A trust distributes your assets after you pass away while allowing you to have more control over how funds are used. For example, you can set up a trust that distributes your gifts over a period of years or as the grandchild ages (for example, apportioning a gift at ages 20, 25, and 28), or for specific purposes (for example, education, a wedding, or a first house). There are various ways a trust can be set up, including irrevocable trusts and revocable trusts. A trust is only as good as the lawyer (and possibly, tax advisor) who drafted it. State law can impact how trusts function and how taxes are collected on them—even if some grandchildren live in other states. A trust can be expensive to set up, so if you’re leaving a smaller amount (for example, a few thousand dollars) to heirs, you might want to consider another approach.
Custodial Accounts
A Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) account allows a grandparent to give stocks, bonds, and other securities to grandchildren. The account also acts as the custodian of those funds until the child becomes an adult, according to individual state law. However, the grandchild can take possession of the gifts within these custodial accounts as soon as allowed by state law, and you have no control over how the funds will be used. These accounts are subject to taxes on capital gains, interest, and dividends.
Investment, Retirement, and Bank Account Transfers
Bank and investment accounts can be transferred to a grandchild upon your death. They are a simple solution if you don’t need to divide a complex estate among grandchildren or only plan to gift a smaller amount. You can also leave the contents of your IRA or other retirement accounts to a grandchild, although doing so could result in estate taxes and depends on the tax laws in your state. Establishing a beneficiary is often as easy as filling out an online form where you’ll name each grandchild and apportion percentages of the account. Even if you’re planning to leave funds to children, it’s also possible to designate the distribution method as “per stirpes,” the legal term indicating that you want your assets to pass equally to each branch of your descendants.
Educational Savings Accounts and Retirement Plans
These college savings accounts in a grandchild’s name allow grandparents to gift college-earmarked funds before death that grow tax-deferred in investments. Grandchildren can withdraw funds tax-free as long as they use the contents for higher-education purposes. Two popular accounts types are 529 plans: a prepaid tuition plan and an education savings plan, both run by state agencies. Coverdell savings accounts are another vehicle, although not as popular. You can boost a grandchild’s future golden years by establishing a retirement plan in their name. For example, as long as a grandchild has earned some income in the year, you may be able to contribute to their Roth IRA, which offers tax-free withdrawals at age 59 1/2 or if they experience a disability.
Preparing Your Grandchildren for Their Inheritance
The element of surprise isn’t ideal when it comes to inheritances, Asher said. “The last legacy you want to leave behind is a broken family” by creating resentment due to improper planning; for example, leaving one grandchild the successful family business because they expressed a passing interest, and leaving cash to another grandchild. After your passing, one grandchild might acknowledge that they aren’t interested in business ownership, and the other grandchild might feel shorted by cash versus a long-term investment that makes millions over decades. Furthermore, grandchildren and your children (their parents) might argue over the inheritance. Call a meeting to discuss your plans—even if your family doesn’t usually talk about money—to share your goals and ask for ideas. Describe how you’d like any money to be used (for example, for college, a first home, or a future wedding). Most grandparents don’t want to see hard-earned money spent on a sports car or European vacation. Even if you plan to leave a smaller amount or only contribute to an educational account, make your intentions clear; for example, perhaps you expect a grandchild to achieve a certain grade point average (GPA) in high school, use the funds for graduate school, or finish college in a certain amount of time. You’ll also want to discuss any potential tax implications or ask your grandchildren to consult with a tax advisor. For example, your grandchildren may owe capital gains tax upon selling investments transferred into their name, or need to file tax waivers or fill out paperwork to benefit from a stepped-up tax basis for certain inherited account types.
The Bottom Line
If you’re hoping to care for your lineage through an inheritance, consult with a professional who can help you assess your circumstances and estate, but don’t forget to consider your grandchild’s needs and desires as part of the process. Help them understand your intentions when you leave them cash, stocks, property, or other assets. A thoughtful and transparent plan will help you avoid post-mortem conflict, confusion, and stress among the people you are trying to help.
