What’s the best way to prepare your heirs to receive an inheritance?

Once you’ve put your estate plan in place, don’t hesitate to share your plan with what may be your most important audience: your heirs.

You may not want to spend more time thinking about what happens after you’re gone. You also may not want to create a sense of entitlement among your heirs. But sharing your plans and goals for your heirs can strengthen the foundation for preserving the wealth you’ve accumulated for multiple generations.

With the following four steps, you can prepare your heirs to be stewards of your legacy and continue to build your family’s assets for future generations.

Share your goals

Be open about how and why you’ve planned to pass your wealth to your heirs. Talking about death is never easy, but openly communicating your intentions helps shifts the focus to the positive goals you hope to accomplish. It also allows you to relay how your wealth was built. Understanding history and legacy gives children a sense of collaboration and a stake in the future.

Encourage your children to share how they foresee utilizing and benefitting from their inheritance. One way to help the next generation appreciate your goals is to have them engage in discerning their own goals and think about how those goals may be fulfilled.

If you are transferring a business or large investment, it is particularly important to share your values and your aspirations for what that asset might look like in the future. Helping your children understand the history behind your business helps validate them as the new owners. They aren’t just receiving wealth or an asset, they are becoming caretakers of the business and your legacy.

As they gain that sense of ownership, take time to give your heirs advice on how to establish their own financial goals and plans, while avoiding pitfalls, questionable investments and extravagant spending.

Put it in writing

Conversations and regular family meetings are effective, but you might also consider writing a letter to your children, grandchildren or other heirs. This written communication can work alongside your formal estate and trust documents, signaling your broader intentions in an informal manner.

Often known as a “letter of intent” or a “letter of wishes,” writing things down provides a way to relate your preferences while expressing your values and feelings. Sometimes it’s easier to express details or emotions in writing and addressing it to your heirs carries a personal touch that can have a greater impact. It’s also a place where you can share context related to family history and your mission statement, tying them to how your family has built, maintained and shared assets over the years.

A letter also can provide a framework for the decisions contemplated in your estate planning documents. For example, it can outline how your trustee should think about making distributions for health care or education in support of certain heirs or how to exercise discretion for larger distributions.

Keep in mind that a letter is not a binding, legal document; it does not replace a will or trust. But it can be a nice supplement to those documents while bringing emotional clarity to beneficiaries and the trustee.

Use the flexibility of trusts

As you create your estate plan, remember that a trust structure can direct how assets should be distributed after your death, as well as manage the gifts you make during your lifetime.

The flexibility of a trust allows you to customize terms to match the life stage of each beneficiary and to adapt to circumstances as they develop over time. For example, you can create provisions for:

• Different types of access: direct the right to income at certain ages; define the standards for the trustee’s discretion, including mandatory distributions dependent on beneficiary circumstances. You can also define certain types of distributions (for education, support of a business, medical needs, or other personal needs).
• Different types of control and responsibility: you can provide the ability for adult beneficiaries to become a co-trustee at a certain point; the right to remove and replace a trustee, or the right to become sole trustee and gain responsibility for assets held in the trust.

How you draft trust directives is critical, so make sure you, your trustee and beneficiaries understand your intentions. For example, there is a major difference between granting $1 million, as opposed to granting the money in specific increments, or directing that the money is to pay for education or medical expenses. Make sure the terms of your trust are clear and understood in advance.

Help them understand tax implications

Prepare your heirs in advance for the tax issues that may come with inherited assets.

You and your beneficiaries should be aware of the transfer taxes that may apply to your estate. This encompasses estate, gift and generation-skipping transfer taxes. The good news is that the federal estate and gift tax exemption currently is $13.99 million per person, or $27.98 million for a married couple. Amounts below those exemption levels are free from federal gift and estate taxes.

If your estate is above the exemption amount, the amount over the exemption will be taxed at 40%. That tax, however, can be minimized by making gifts during your lifetime.

For your beneficiaries, if their individual estates will likely be over the exemption amount, they also should be thinking about gift and estate tax planning. This applies both to how they plan for their own assets and how you structure the gifts you leave for them. With a properly structured trust, it may be possible to keep additional assets out of their estate.

It is also helpful for you and your heirs to understand how income taxes work with inherited assets. The good news is that inheritances generally are not subject to federal income tax. Also, assets that pass as part of your estate receive a “step-up” in income tax basis. This means capital gains accumulated during your life disappear at your death.

In general, your heirs will not have immediate income tax burdens as a result of your death. But different types of assets carry special tax concerns as they move forward. In addition, if you are leaving assets in trust, special tax rules apply to determine the extent to which your beneficiary will pay taxes based on the trust assets. Trusts pay income taxes at higher rates than individuals. As a result, it typically is a good tax result when income is taxed to a beneficiary rather than the trust.

Be open to the future

Getting your estate plan in place is important, but it shouldn’t stop once your legal documents are complete. Share your plans and intentions with your beneficiaries and your trustee. Helping to guide your heirs through the future process can remove anxiety and questions. Being forthcoming with your preferences will help your heirs take an active role in how family assets move to future generations. For more guidance on sharing information about wealth with your heirs, see our related article How and When to Talk to the Next Generation About Wealth.