Legacy Planning and Estate Planning: They're Not the Same

Financial Planning


Retirement Red Zone

Legacy Planning and Estate Planning: They're Not the Same

Some people use legacy planning interchangeably with estate planning. But there is a distinct difference: While estate planning tends to focus on basic documents and assets, legacy planning focuses on your intentions for your wealth.

Published by Motley Fool Wealth Management Wed, Sep 7, 2022

read time 6 min read

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Do you plan to leave money to your kids, grandbabies, or charity?

An estate plan can identify your assets and get all the documents and directives in place to protect your heirs from a long probate process or losing some of your estate to unexpected creditors or lawsuits.

But what if you want more control over when and how your wealth is disbursed and spent? Then you need a legacy plan.

Taking control

Some people use legacy planning interchangeably with estate planning. But there is a distinct difference: While estate planning focuses on basic documents and assets, legacy planning focuses on your intentions for wealth.

With this different focus, legacy planning can create more detailed and nuanced inheritance plans.

Who should consider planning for a legacy?

There are many reasons individuals desire control over how their assets are distributed after they pass. For example, you may be concerned that passing a large lump sum to heirs when they are too young could lead them to misspend it, or to become de-motivated to develop their own career and wealth. Or you may simply want to cap how much goes to your children and give the rest to charity. In these situations, choosing milestones or age criteria for when the money can be inherited is normal.

Here are several examples of people who might desire a legacy plan.

Consider a legacy plan if you…

  • have a large estate and want it disbursed over time
  • wish for your wealth to be spent on certain things (e.g., education)
  • want heirs to achieve milestones (age, education) before receiving an inheritance
  • desire to shield the wealth from too much tax exposure
  • aim to give some wealth to charity
  • have a business you want to be managed a certain way after your death
  • need wealth to be managed for heirs who have special needs

How to structure your legacy assets

Many people use trusts for legacy planning. They work like this: A grantor (trust maker) places assets—like cash, stocks, bonds, or real estate deeds—in an account to be managed by a trustee according to guidelines established by the grantor for named beneficiaries.

There are many kinds of trusts. Testamentary trusts are activated by a will while living trusts are created while the grantor is alive. Living trusts can be either revocable or irrevocable, but after the grantor’s death, all trusts become irrevocable.

  • A revocable trust allows the grantor to retain control. The main purpose of this trust is that, upon the death of the grantor, assets bypass the probate process and are disbursed to, or managed for, the beneficiaries. Because it is revocable, these assets are not protected from current creditors and do not avoid the 40% federal tax on estates greater than $12.06 million. But upon the grantor’s death, the trusts become irrevocable and are no longer changeable or reachable by future lawsuits or creditors.
  • An irrevocable living trust forces the grantor to give up rights to the assets and the ability to make further changes after establishing the trust guidelines. Legally, the grantor no longer owns these assets. They are managed by a trustee according to the guidelines for the beneficiaries. Upon the death of the grantor, all assets bypass both the probate process and the estate tax. They are also out of reach by future creditors’ claims.

When a grantor dies, beneficiaries do not immediately incur taxes for assets still held in the trust, as these trusts pay their own tax on assets they hold. But they distribute trust income annually to beneficiaries (as a pass-through entity), which beneficiaries must pay tax on. When assets such as stocks and real estate are disbursed to beneficiaries, depending on the type of trust, the current value usually becomes the asset's cost basis.1

The taxation of trusts is complex, so it makes sense to consult a tax professional. But in general, they potentially can be very effective in avoiding capital gains tax and some estate tax upon wealth transfer.

Shielding wealth from estate and gift taxes

The Federal government and some states tax estate and gifts. In 2022, estates less than $12 million do not incur federal tax. This high amount was part of the Tax Cut and Jobs Act (TCJA) of 2017, but it’s set to expire in 2025, at which time the cap for non-taxable estates could fall to $5 million.2,3

For estates above the cap, the value of the assets that are not shielded (using trusts, for example) is taxed at 40% of their current value. That means an estate currently valued at $13.06 million could have $1 million that is taxable at 40%, resulting in a $400,000 tax bill.

Legacy planning can uncover various ways to reduce this tax. For example, you may choose to give money to heirs while you’re still living to reduce your taxable estate tax. In 2022, you can give up to $16,000 per year per person without the amount being applied to your lifetime gift and estate tax limit of $12.06 million.

So, for example, if your estate was $13.06 million, you could give $16,000 to each of seven people every year for 10 years and thereby shield $1.12 million from taxes. This would bring the size of your estate to below $12 million, eliminating the $400k tax bill.

Legacy planning assists you with charitable giving

If you are contemplating giving some of your wealth to charity, you may want to consider a Donor Advised Fund (DAF) or a family foundation.

A family foundation gives you complete control of how your money is donated. But it is complicated to set up and maintain.

On the other hand, DAFs are easy to establish and are managed by professional organizations, such as community foundations. Once donors contribute assets to the DAF, they are the property of the DAF, and the DAF donates them to a specific charity.

DAFs have become a popular means of charitable giving in recent years due to their ease of use, attracting people of vastly different financial means. In addition, donors receive an immediate tax deduction for the donation.4

However, unlike family foundations, DAF donors give up some control over how the assets are disbursed. They can choose from various charitable strategies offered, but in the end, they cannot decide on which charitable organization receives gifts. DAFs also offer anonymity versus the public nature of family foundations.

Avoid common mistakes

There are other ways that people could structure legacies. For example, some people consider using life insurance or annuities as wealth transfer mechanisms. But in general, we don’t think these are effective for legacy planning.

Life insurance is necessary while you have dependents. But after your kids leave home, we believe it is no longer a good way of building wealth compared to other investment opportunities, such as a well-designed stock portfolio.

Similarly, annuities may seem attractive if they offer continued payments for your heirs after your death. However, this feature is usually an add-on and can be very expensive. And it often comes at a cost in the form of lower payments to you while you are alive.

Some final advice

One of the simplest and most important ways to ensure your heirs receive your wealth in a timely, secure, and private manner is to make sure all your accounts have appropriately named beneficiaries. This is the most effective way to ensure your wealth is given to the people you choose.

And when creating your legacy vision, think about your goals for your wealth. For example, you may wish to explore ways to enjoy your assets together with your heirs in your lifetime rather than after. That may be in the form of a vacation home where you can gather and spend time as a family. Or treat your family to experiences they may not be able to afford on their own—such as going to see one to see the seven wonders of the world. Especially for grandparents, spending one-on-one time with grandchildren can be a wonderful gift—for both you and them.

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[1] Smartasset.com, Jul. 6, 2022

[2] Kiplinger.com, Oct. 20, 2020

[3] Investopedia.com, May 31, 2022

[4] Forbes.com, Sept. 27, 2018


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