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  • Writer's pictureBridget Sullivan Mermel CFP(R) CPA

Tax-efficient Giving | Make Your Kids and Grandkids Happy!

When you've reached a point in your life when you know you've got more than enough, you may think about passing along your financial wealth to your kids, grandkids, and charity.

Tax-efficiency means youYou want to give money and pay less tax!

Bridget Sullivan Mermel and John Scherer explain how to give money and pay the least in taxes for everyone involved.

Here's another video we shot about estate planning mistakes:

John's firm website:

For advisors around the US:

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John: As people get to a spot in retirement where their financial security is kind of locked in, and they know they're going to have enough money, oftentimes they shift from thinking about “Will my money last?” to “How do I leave it behind to my family?” On today's episode of Friends Talk Financial Planning, we're going to talk about the best ways to leave money to your family and maybe some reasons why you might not want to leave money to your family. And we're going to cover one big mistake that we see people make in giving money to their family. Hi, I'm John Scherer, and I run a fee-only financial planning practice in Middleton, Wisconsin.

Bridget: And I'm Bridget Sullivan Mermel, and I've got a fee-only financial planning practice in Chicago, Illinois. And before we go any further, please subscribe. That helps us with YouTube and helps more people find our channel. So, John, I'm really excited about this conversation. You talk to a lot of people, and so do I, who are interested in leaving money to their family and they want to do it efficiently. So why don't you kick it off and tell us what your thoughts are.

John: Yeah. As we start this, Bridget, I just want to preface it by saying that sometimes you first ask, “I'm starting retirement. Do I have enough?” And then as you get a little bit older, you go, “Yeah, I'm going to have enough and more than enough. And now what do I do?” And we're going to talk about that to start off here, but then there's also the thing of saying, “Listen, I don't know if I'm going to have enough, but if I do, I want to leave it.” So there are sort of two topics. When somebody says, “Jeez, I want to leave money to my kids,” there’s a lot of confusion on what's the best way to do it, and how do these things work.

And there're three places where people have their money in retirement, and the best place for people to leave money is the Roth IRA, because it grows tax free. If I take it out during my life, it comes out tax free, but also if I leave it to my kids, they can take all the money out tax free as well. So when we have folks that are in a spot where they say, “Hey, there's going to be some money left behind, what's the best place?” targeting that Roth IRA, I think, is the number one place to leave money behind the kids. And then close behind that is the taxable accounts. And I'm talking about things like the brokerage account at Fidelity or Schwab, where you have a 1099 every year, you get dividends and capital gains that come out of it.

And why that can be a really good place is that if I've invested $10,000 in that account, now it's grown to $100,000, if I sell that, I've got to pay taxes on that $90,000 of gain, but if I leave it to my kids, they can sell that $100,000 and pay no taxes under current tax law. And it's what's called in our jargon, a step up in basis. But they can sell that without paying any taxes. And a lot of times people forget that that money can go to my kids tax free if they don't sell it or gift it to them. So those are really the two big ways that we talk about leaving money behind on an efficient basis. And I don't know if that resonates with you or how you talk with your clients, but I'm interested in your take.

Bridget: Yeah. This is an interesting conversation. We're talking mainly about how to set up your estate in this situation. In other words, how to do that most effectively and which buckets are best to pass down. The Roth IRA is a great bucket to pass over, especially if you have some kids with high incomes. If you've got some kids who are doing really well financially those are great people to give Roth IRAs. Everybody will appreciate them, but the high-income people especially. And then the taxable accounts are always wonderful. And one of the things about those, if you inherit one, is that it's so flexible. You can just take the money and use it right away, which people appreciate. And there's a step up in basis, like you mentioned, so you don't have to worry about paying capital gains, et cetera.

John: As you were talking, Bridget, you reminded me of a friend that I was talking with the other day. She's a little bit older. She's retired now, and she said, “Hey, I'm interested in leaving money in my estate to a charity as well as my kids.” And we were just having this conversation over dinner one night, and she was saying, “Hey, I've got this Roth IRA, and it’s just the right amount that I want to give to the church, so I think I'm going to do that.” And she just wanted to ask my opinion.

And I said, “Well, listen, one of the worst ways of leaving money to family is in an IRA, a regular IRA, because then they have to pay taxes on it.” And in this case for my friend, if she had even carved off part of her regular IRA and left that to charity, the charity would take the money out, and they wouldn't have to pay any taxes because they're a nonprofit. And if she leaves her Roth IRA to her kids, the Roth IRA goes to the kids tax-free. So in her head, it made total sense to say, “I got this little bucket. It totally fits. That's what I want to give to charity.”

But she would have given a tax-free asset, a tax-free investment to the charity, which is already tax-free, and she would have given her IRA, which is fully taxable to her kids who are going to have to pay taxes. So that's one of the places where it’s important to think about the type of IRAs. And again, if I leave an IRA to my kids, they're pretty happy to get the money, but there're some tax consequences. So the little five-star tip is that if you're interested in leaving money to charity in your estate, then using an IRA can be a really great way to do that.

Bridget: Yeah, I love this tip. It's really a wonderful tip. The other thing is that changing the beneficiaries on your IRA is quite easy, and so it's another reason why I like it. So if you decide you want to change which charity you want to give to, you can just change the beneficiary on your IRA. And most IRAs you can set a certain amount or a percentage, so you don't have to give your whole IRA to the charity of your choice.

The other thing I just want to keep in mind though, is this is better for major charities versus the local theater group. It's got to be a charity that's somewhat established. It's got to be around when you die. And someplace like the local upstart might have a hard time handling it, et cetera. Churches, however, are all set up for this because even if it's a small church, through their denomination, through the Lutherans or whoever they're associated with, they've got the ability to handle these kinds of donations.

John: As you were talking about this, I was thinking maybe we'll do a whole episode on leaving money behind. These are some really great tips. I want to circle back on one thing. When somebody says to me, “Hey, John, we'd like to leave money to our kids,” in some cases, people go, “Listen, I'm not sure if I'm going to spend this all during my life, but if I don't, I wanted to go to the kids.” Here's the ordering of options. Roth IRA is great and brokerage account next. There're other times where you get to a spot in life and you go, “I'm never going to spend all my money. I'm going to leave some money behind to the kids. How can I be efficient with that?”

One of the things that we always bring up with folks that are in that position is saying, “Listen, yes, we can set it up just like we talked about, so the money gets left behind to your kids in 10 or 20 or 30 years,” but we encourage people to think about making gifts to the kids today while they're still around. We've got some clients with whom we were having this same conversation a week or two ago. These clients were in their mid-seventies and said, “Well, jeez, we're not going to spend the money; we want to leave it behind.” Their kids were approaching retirement and trying to figure out how to get there.

And I happen to know the kids separately. And I said to the client, “Well, listen, absolutely we can leave this money behind, but any year you can give $16,000 per person without any gift, taxes or anything else.” So a married couple could give $16,000 each, which is $32,000, to their son in this case. And if they wanted to leave money to their daughter in law, they could do the same thing to the daughter in law tax free. And think about how useful that money might be for the kids who are 40 or 50 or even 60 as they're getting into retirement or trying to remodel their basement or those sorts of things.

And so rather than saying, “Hey, let's leave money behind in 30 years,” it’s important to ask, “Where are the kids going to be in 30 years?” They’ll probably be sitting in the same seat that mom and dad are in right now, thinking, “Hey, we're already retired; we've got it going on.” Whereas right now, hey, maybe a $10,000, $20,000, or $30,000 gift would be a huge benefit. Plus, mom and dad then get to see that money being used. Not the right answer for everybody, but you should at least consider that if you're in that spot.

Bridget: Yeah, and interestingly, I had one client situation where they had most of their money in IRAs and Roth IRAs, and so they didn't have much in taxable money. And they wanted to give their money kids for down payments. Their kids were having kids and they wanted to help them buy houses. And so, they ended up taking money out of their taking the gift money out of their Roth IRAs, because they could take it out tax free and they happened to be in the 12% bracket.

So if they took it out, they took as much as they could out of the IRA, but we didn't really want them to launch them into the 10% higher tax bracket, so we took the money from the Roth IRAs, even though usually you like to keep the money in Roth IRAs as long as possible. But this is a great idea. It was a great time to take the money out, because it would be tax free for the clients to take the money, and then they could just give it to the kids or if they wanted to do something else with it, that would have been fine too. So it's counterintuitive, but it worked out in this situation.

John: That is such a great reminder that this is all unique to everybody. These are ideas to take to your situation. Everybody's individual situation is different. I want to make sure we talk about the one big mistake that we've seen people make. And I just got done saying, “Hey, gifting money to kids can make some sense.” The one big mistake is we've had people where they get to the end of life and go, “Listen, I know that it's going to be a short time horizon.” And if you've got something that you bought a long time ago at a low cost—you bought some property—and now it's gone way up in value and you think, “I want that to go to my kids.” Gifting that while you're alive, however, is not a great way to do it if there's a great big gain that's built into it.

And we had a client whose mom had bought some property years ago. The mom had bought it for $50,000, and now it's worth $500,000, and said, “Jeez, I want that to go to my family, and so made a gift of that during her lifetime. And what happened is when mom passed away, rather than getting that step up in basis and being able to sell it with no taxes, the kids were now in a position where if they ever wanted to take money out of that or make a sale on that, they had to pay taxes, because most of the value was all taxable to them. So making gifts can be a great thing, but be really careful with that step up in basis, which can be a source of huge tax savings. You can save literally tens of thousands of dollars by being smart about that.

Bridget: Yeah. So you can see why mom and dad want to give the farm to the kids, because they don't need it anymore, and they don't want to take care of it.

John: Maybe they’re trying to avoid probate. By making a gift they don't have to worry about some of these things.

Bridget: But, jeez, you might end up paying a lot more in taxes by doing it before you die. And I'm sure your kids would be happy to contribute to the upkeep, et cetera, so that they can inherit it and get the step up the basis and save a ton of money on taxes.

John: Yes.

Bridget: So that seems like a great place to wrap up. I’m Bridget Sullivan Mermel, and I own a fee-only financial planning practice in Chicago, Illinois.

John: And I'm John Scherer. I run a fee-only financial planning practice in Middleton, Wisconsin. And if you like what you hear on our show, Bridget and I are both members of the Alliance of Comprehensive Planners. To find an advisor in your area, you can check out

Bridget: And please subscribe.

At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.

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