‘One child’s portfolio will have an additional five years of growth’
“One child’s portfolio will have an additional five years of growth. Any suggestions?” (Photo subject is a model.)
Dear Quentin,
I am single and have no children. I have two grandnieces, ages 5 and 10. I want to leave them each an inheritance from investments that will become available when they become 18. I would like the amount they inherit to end up in the same ballpark. One child’s portfolio will have an additional five years of growth. Any suggestions?
Grandaunt
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If you invested $115,647 for the 10-year-old child and $84,353 for the 5-year-old, you could end up with approximately $214,000 for each child when they turn 18.
Dear Grandaunt,
What a novel idea, if a complicated one. Just be aware of the risks of giving 18-year-olds a lump sum.
The simplest and, for the purpose of this column, least fun way to do this would be to put your brokerage account into a trust, and adjust the terms so that they both can only access the trust when they are both 18 (or even 21, if you think 18 is too young); most estate planners would use age-based staggered distributions. On the one hand, one grandniece will have to wait until she’s 23 to access this trust; on the other, it will allow her money to grow for another five years, and the other grandniece can learn from the example of leaving it in the account so they can experience the benefits of compounding where the interest on the principal grows, in addition to the principal. And, remember, the timing of investment returns, which could differ for each grandniece, can have a big impact on their respective outcomes.
When it comes to trusts, the world is (almost) your oyster. The best part about putting their respective inheritances in a trust is that the trust will bypass probate. In this guide, Klipinger points out that there are several types of financial assets that can be owned by a trust – including bonds and stock certificates, nonretirement brokerage and mutual-fund accounts, money-market accounts, and even cash, CDs, checking and savings accounts, in addition to safe-deposit boxes and real estate.
“Funding your trust with bank and brokerage accounts generally requires new account paperwork in the name of the trust, as well as signed authorization to retitle or transfer the asset,” Klipinger says. “Likewise, physical bond and stock certificates require a change of ownership to be completed with the stock transfer agent or bond issuer. You may also wish to fund the trust with a checking or savings account, though it is important to carefully consider any implications if these accounts require regular withdrawals or activity.”
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Timing the outcome
Alternatively, let’s say you have $100,000 to invest in each child. Let’s assume an annual return of 7.5% over the eight years for the 10-year-old child and 13 years for the 5-year-old child. How much do you invest in each child’s brokerage account? If you invested $115,647 for the 10-year-old child and $84,353 for the 5-year-old, you would end up with approximately $214,000 for each child when they turn 18. But that does not account for fluctuations in the market; if there was a slump after year 10 or a sudden boom after a fallow period, it would skew your results.
When a trust beneficiary approaches age 18, the biggest change is often the beneficiary’s legal right to control the assets – in this case, your grandnieces – and this coming deadline typically impacts your asset-allocation strategy. The portfolio generally shifts from aggressive growth toward more conservative investments to protect the principal as the distribution date nears. The longer time horizon of the trust, the more runway the assets have for higher-risk – or more growth-oriented – investments like stocks.
Leaving these accounts in your will so they go to your grandnieces on your passing or placing the brokerage accounts in a revocable trust – rather than an irrevocable trust that you technically no longer own and is not subject to change – will help ensure that they will receive a step-up in basis when that time comes. That means your grandnieces would pay capital-gains tax on the “stepped-up” value of the assets (the higher value at the time of your death, rather than having to pay more capital-gains tax on the original $100,000 investments).
“Step-up in basis is a tax provision allowing the value of inherited assets to increase to fair market value on the decedent’s date of death,” says Darrow Wealth Management in Boston and Needham, Mass. “This increases the tax basis, which determines capital gains or losses when the asset is sold. In addition, assets receiving this favorable taxation are always given a long-term capital-gains holding period. This happens regardless of the actual holding period at the decedent’s death.”
A word of caution
You can also set up custodial accounts, opened under the Uniform Transfer to Minors Act (UTMA) or the Uniform Gifts to Minors Act (UGMA), for your grandnieces. UGMAs typically contain securities, while UTMAs can hold other assets, including real estate. What’s more, custodial accounts are also common investment vehicles for children. With these types of accounts, you can take advantage of the annual gift exclusion amount, which for 2025 and 2026 is $19,000 per person, without any of it being subject to a gift tax. The lifetime gift-tax exclusion will rise to $15 million next year from $13.99 million (but this will likely change over the next few years).
A word of caution: Any money you deposit in such an account is an irrevocable gift, much like putting stocks in an irrevocable trust, meaning you cannot take it back and that the funds have been removed from your estate, and they do not get a step-up in basis. (One sidenote: Irrevocable trusts can contain spendthrift protections; UTMA assets cannot.) The courts have ruled that 529 plans, which people use to save for their children’s or grandchildren’s education, should be treated as gifts for tax purposes, even though they’re in a parent’s name, according to the law firm Goldsberry, Portz & Lutterbie, which reviewed a range of such cases across the country.
To equalize their inheritance later, you can adjust the distribution in your will or trust, reducing your grandnieces’ shares by the amount you have gifted each. A “hotchpot clause” in your will ensures fairness by effectively deducting the advanced gifts from their inheritance share, retroactively calculating what each heir has already received and helping to ensure that both grandnieces get an equal amount. You can also set up a “sub trust” with an equalization clause or formula-based distributions, allowing trustees to adjust distributions based on age, financial need or other milestones.
Your grandnieces are fortunate to have such a forward-thinking and generous great aunt.
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