Want to Create a Lasting Legacy? Four Issues to Address

A man rests his index fingers on the L and the Y in the word "legacy," which is spelled out in wooden blocks.

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There will come a time when you realize that you have spent a lifetime building your wealth and you want to know how it can provide a lasting legacy to the next generation. You might be at that stage today or see it as a future event. Either way, you need to plan for it. This type of wealth planning is what we call legacy planning.

If the goal is to leave your wealth to your children, it may seem like a matter of simply bequeathing these assets to them. But if there is any concern about their ability to manage this wealth, or about them possibly losing these assets to creditors, legacy planning should be done.

For some of our clients, a major (and valid) concern is leaving so much wealth to their children that they lose the motivation to build their own wealth or develop their own careers. Therefore, an underlying and critical question is determining how much of your wealth to leave to your children and if you should place any guardrails on how funds are used. In determining this, it is important to define the level of financial security you would like to provide for your children.

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The following are the actions and issues that we encourage everyone to address to ensure proper legacy planning:

Getting your estate planning documents in order
Bequeathing your wealth to leave a lasting legacy
If applicable, planning to minimize the impact of federal estate and gift taxes
Determining whether you also want to leave a charitable legacy

Getting your estate planning documents in order

For estate planning, the key documents for most are as follows:

Revocable living trust (RLT). Also known as a family trust, in this type of trust the person who creates it maintains full control of assets titled to the trust while alive (as a Trustee) and then directs how assets are passed on when one and then both (if applicable) settlors/spouses pass away.
Pour-over wills. Generally used in conjunction with revocable living trusts, these function to direct assets to the RLT that are not titled to the RLT.
Durable power of attorney. These documents designate who can make financial or legal decisions for you if you are unable to make those decisions due to being incapacitated. Many times this power is “springing,” which means it becomes effective (springs into action) if certain circumstances occur (such as incapacity). Unlike an RLT, a durable power of attorney does not transfer asset ownership at death. Although an RLT can deal with possible incapacity, a durable power of attorney should still be created to manage assets that are not titled to the RLT and to provide an agent the power to sign legal documents such as tax returns and contracts.
Health care directives. Generally consisting of two documents — a living will and durable power of attorney for health care — these documents outline your wishes for your medical care. A living will, also known as directive to physicians, provides guidance about someone’s health care wishes if he or she becomes too sick to be able to communicate them. These can include directions regarding pain medication, artificial hydration and nutrition, and resuscitation. A durable power of attorney, also known as health care proxy, appoints an individual to make health care decisions if the principal (person who made the appointment) is unable to do so.

In certain jurisdictions, it may be more favorable to use a will (e.g. living will) over an RLT. Nevertheless, because of the RLT’s ability to avoid both the cost and delay caused by probate, an RLT (coupled with a pour-over will), especially in states with high probate costs like California, is generally chosen as the main document to transfer wealth. This is particularly true if you would like other options to leave your wealth to your children or other heirs other than an outright distribution of your estate.

Leaving a lasting legacy

It may seem natural to think that parents should just leave all their wealth to their children or loved ones, and in many situations, this may be the best option, depending on the size of the estate and the financial wherewithal of the recipients. For others, especially those with sizable estates, the concern may be how much to leave, and if there should be any guardrails put in place for assets that are inherited.

It is important to address several questions when framing the goal of leaving a legacy:

How much wealth is enough for the children?
At what age should the money be transferred?
Should we create incentive milestones (i.e., college graduation) or other goals before the money is transferred?

For parents who have created their own wealth, the thought of leaving millions outright to their children may not align with their own values regarding work ethic and the belief that children should build their own wealth. In this situation, the parents may desire to leave a portion of the estate, rather than the entire estate, especially if they have a desire to leave a charitable legacy.

The second concern is that the children could lose the wealth inherited, not only because of possible mismanagement but for other reasons beyond the children’s control. If the estate is left outright to the children, that means they have full control over those assets and if they are sued or have any other legal action against them, creditors could go after those inherited assets to settle any claims.

This can be avoided if inherited assets are left to a properly drafted and structured irrevocable trust, where the assets will likely be beyond the reach of creditors. In addition to providing income or assets for the children to ensure their financial security and providing asset protection, an irrevocable trust can also contain language to incentivize certain behaviors, such as making funds available to start a business or to attend college or graduate school.

Minimizing transfer taxes: Gift and estate tax planning

There is often a misperception that when one has their estate planning documents drafted, such as a revocable living trust, they have also undergone estate tax planning. This is often not the case, and it is likely that further planning for estate taxes is needed, especially if only the basic estate planning documents mentioned previously are drafted — and especially if a family has substantial wealth that exceeds the current estate tax exemption amounts. Further planning will be needed to minimize estate taxes.

If you have a large enough net estate and proper planning is not done to minimize transfer taxes (e.g., estate and gifts), these taxes can significantly reduce the estate that will be left as a legacy to your family. This issue is exacerbated if your estate is made up of largely illiquid assets, such as real estate or a closely held business, since it could be difficult to create the necessary liquidity (have the cash) to pay the estate taxes without having to sell these assets.

Some states also have their own estate and/or inheritance tax as well. For example, while California does not currently have an estate or inheritance tax, Hawaii does (although the tax rate is much lower than the federal estate tax). That is why, depending on the legacy goals, it is important to undertake estate and gift tax planning to minimize the negative impact of these taxes, and/or help create the liquidity to pay them.

As a result of the 2017 Tax Cuts and Jobs Act (TCJA), the estate and gift tax exemption amounts at that time were doubled. This substantial increase is beneficial because only those families with a net estate greater than the exemption amount will have to pay estate or gift taxes. Under current law, for 2025, the exemption per person is $13.99 million. If the net estate is greater than the exemption, there is a 40% tax levied on the excess. So, for each $1 million over the exemption transferred, about $400,000 in estate taxes will be owed.

The increased exemption is set to expire at the end of 2025, when it will return to an inflation-adjusted $5 million amount, which is estimated to be about $7 million (the tax rate is scheduled to remain at 40%). Since Donald Trump won the presidential election and the GOP has control of both Congress and the Senate, it is likely that the estate tax provisions of the TCJA will be extended, but as is the case with anything rooted in politics, there is no guarantee that this will occur. As a result, one’s estate tax plan needs to be flexible and be adjusted as estate tax laws evolve and change.

Do you want to leave a charitable legacy?

Is there a charitable cause you believe in and would want to leave money to? Under current tax law, when assets are bequeathed to a charity, or a charitable structure such as a private foundation or donor-advised fund (DAF), these assets are not subject to estate or gift taxes. Even though donated assets will not go to children or other loved ones, there will be no estate or gift taxes resulting from the donation.

For many, given the choice of paying taxes or providing funds to a charity, they would prefer leaving assets to charity. Even with this added tax benefit, there are many who believe strongly in providing a charitable legacy, and for those individuals, this option is a win-win.

Once charitable goals are defined, there are a variety of charitable giving strategies and vehicles to choose from, each with its own advantages and disadvantages. The selection of which to use will depend on the client’s overall goals.

As has been seen with many wealthy high-profile families, such as the Walton family of Walmart and the Gates family of Microsoft, leaving assets to charitable causes can have a lasting positive societal impact, and regardless of the size of one’s estate, any funds donated to charity can have a positive impact. As part of legacy planning, you should determine if leaving a charitable legacy is important to you.

So, that is legacy planning, the element of wealth planning that determines what your wealth will do beyond your lifetime. Whether it is setting your children up for financial freedom, supporting a charitable cause, or both, there are many things that need to be addressed to ensure your wealth leaves a lasting impact.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Daniel Fan is a Partner in the Orange County office of Cerity Partners, LLC. He is an attorney with over 20 years of experience as a high-net-worth wealth planner and specializes in evaluating and optimizing clients’ financial situations to help them obtain their financial goals. Dan has extensive experience in areas such as income and estate tax, business succession, risk management/insurance and retirement planning.