As the father of more than one child, I understand the desire to try and treat children as equally as possible. You certainly don’t want one child to think you love him/her any less, or more, than your other children (though children will inevitably feel that way at one time or another), and you want the best for all of your children. But while children may share the same parents, may grow up in the same house and may be raised in the same manner, they are very much like snowflakes. Each one is truly unique.
Some differences are apparent from the very beginning, while others emerge over time. Some differences, such as differences in health, may be largely decided by fate. Other differences, such as the difference between children’s incomes or financial well-being, may be more the product of choices, such as a child’s chosen profession.
The more different children become, the more parents may be tempted to treat them unequally at death (provided those differences are not merely the product of poor life choices). This, of course, is an intensely personal decision for many parents, and emotions can span the spectrum. Some parents are determined to “help out” a needier child more when they are gone. Others are set on treating their children equally upon their passing. Some would like to leave greater amounts to one child than another, but are concerned that doing so might create family problems after their death or lead to incorrect assumptions (“see, mom and dad really did love him more”).
For those not set on a predetermined course of action when developing an estate plan, there are definitely scenarios where, from a purely financial perspective, it can pay to treat children differently. In fact, doing so can, in some cases, leave everyone with more than they would have otherwise.
One common scenario where unequal treatment of children can be worth considering is when one or more children have special needs. Children with special needs often receive various state and federal benefits that are means-tested. Those benefits can be reduced, or eliminated altogether, if that child has a certain assets and/or income that exceed certain thresholds. In order to prevent the loss of these benefits when leaving assets to such persons, a special needs trust, also known as a supplemental needs trust, is often used. The big benefit of these trusts is that assets can be left to a child and used to provide certain support without impacting their federal and/or state aid. One big downside of special needs trusts though, is that any income received by the trust that isn’t distributed out is taxed at trust tax rates.
Trust tax rates are brutal. Whereas individuals don’t get to the top tax bracket in 2017 until their income exceeds $470,700 if married or $418,400 if single, trusts get there at income levels that exceed only$12,500! So what can you do?
Well, suppose that you have two children; one with special needs and one who is in good health with a modest income. Now imagine a scenario where you have $500,000 put away in your traditional IRA. Other than that, your only other asset is a $400,000 non-retirement account CD.
The initial inclination might be to leave 50% of the IRA and 50% of the CD to the healthy child directly, and the remaining 50% portions of each to your special needs child via a special needs trust. There is nothing wrong with this plan, but it’s important to realize that, in an effort to try and treat the children as equally as possible, you will almost certainly create an inequality. The portion of the IRA left to the special needs trust will likely be taxed at much higher rates than the portion of the IRA left to the healthy child outright.
As an alternative to the 50/50 split, you might consider leaving 100% of the CD, which would be 100% tax free to the special needs trust. Doing so would not only prevent trust tax rates from eating away at the value of the inheritance (though it could impact future earnings on the inherited amounts), but would avoid the trust from having to worry about meeting the see-through trust rules in order to “stretch” distributions. In a similar manner, you might leave the entire $500,000 IRA to your healthy child. True, $500,000 is more than $400,000, but that ignores the taxes that are still owed on the IRA.
In the end of this scenario, by treating your children in an unequal manner like this, they would likely both end up with more (particularly if the health child utilized the “stretch IRA” concept) than if you chose to treat them equally. Does that mean this is the “right” way to leave assets? Of course not. There is no right way or wrong way 100% of the time. The facts and circumstances surrounding your estate and your children are almost certainly different in some way than the example above. Not to mention that when you’re creating your estate plan, you’re talking about what to do with your assets. The “right” way is whatever way makes you happy. This is simply another way to look at things and another option to consider.
Sometimes, inequality can pay dividends for everyone and be the fairest way to structure an estate plan.