Perhaps you are not convinced that you should set up an estate plan even though you have assets that you want to leave to your adult children. Perhaps you have a heard of a “shortcut” to avoid the inconvenience of estate planning. If you are in that camp, I want to warn you that there are some terrible ideas out there. Many of these commonly held ideas were concocted by people who believe they know best – though they have obviously not considered all possibilities of what can go wrong. Too many of these “strategies” can create conflict among families and cost your children a great deal of money and stress.
If you believe that you and your children all get along wonderfully, and none would ever go against your wishes, you might be tempted simply to tell your children (or even just one of them) how to divide up your assets when you're gone rather than put it in writing. However, even if your children are all of the same mind and plan to follow your directions, it may not be entirely up to them. Without a written document, any assets you own that exceed $150,000 in value must go through probate. Because “oral wills” have no weight in court, it would be up to a judge and the intestate laws of California, not you or your desired heirs, to decide who gets what. Alternatively, if you left everything for one child to decide, that child might not do exactly as instructed, and resentment amongst the other siblings can create hard feelings, at best. This is one strategy to dismiss immediately as a terrible idea.
Instead of setting up a trust, some people figure it would be easier to just name their children as joint tenants on their assets by adding the children to the title of the house or making them a co-signor on bank accounts. This simple fix idea strategy is based on the idea that children should be able to assume full ownership when parents pass on and at the same time it keeps the property out of probate. In a perfect world, that is just what would happen in every instance. However, when you pick the joint tenancy route, you are putting your property at risk. A joint tenancy doesn't protect your property from your children's creditors since they are on title, the property is now considered theirs as well as yours. When you signed that deed, you gave away part of your property. So, if any of your children (i.e., your joint tenants) found themselves in any kind of financial difficulty, their debts could eventually result in a forced sale of your property or a levy on your financial accounts.
Plus, there is another issue – capital gains taxes. Choosing the joint tenancy “shortcut” subjects your children to otherwise avoidable capital gains taxes because they do not receive a full step-up in the cost basis if they are put on the title during your lifetime. However, if your children take title after your death, your heirs can get a break on the capital gains taxes because the basis for the heirs gets “stepped-up” to its value at the time of your death. Bottom line, your children will pay more capital gains taxes with joint tenancy.
If you want to read more on the pitfalls of joint ownership, please see this blog post.
Giving Away the Inheritance Early
Some parents decide to give their children their inheritance early – either outright or incrementally over time. But this strategy comes with several pitfalls. First, if you want to avoid hefty gift taxes, you are limited to giving each child $15,000 per year – for a couple, it's $30,000 per year per person. Second, gifting your children a yearly amount will probably diminish your legacy, because they might spend it rather than investing it – or, worse, it might end up going to creditors or an ex-spouse. Third, you can have a real problem if your own situation changes and you need to re-evaluate your finances. By then it's too late. You don't want to be dependent on your children giving the cash back if you require it for your own needs.
Shortcuts and “strategies” like these may look appealing on the surface, but they can actually do more harm than good. Let's start a conversation and consider all of your possible solutions.