Passing wealth to the next generation is a goal for many families.

However, the path from your hands to your heirs’ is often lined with potential pitfalls, from unnecessary taxes and legal challenges to the unforeseen circumstances of your beneficiaries’ lives. To better maximize and safeguard your legacy, you’ll need to take proactive legal and financial-planning steps. Here is a guide to the key strategies for protecting your family’s inheritance.

The power of trusts

The most effective tool for protecting an inheritance is the trust. Unlike a will, which primarily dictates how assets are distributed after death, a trust is a legal entity that holds them for your beneficiaries, providing layers of control and protection.

A common choice within this category is a revocable living trust (RLT). While you are alive, you maintain complete control over the assets; when you pass away, the RLT allows the assets to bypass the lengthy, costly public court process called probate. This route may offer a faster transfer of wealth while maintaining privacy regarding your assets.

For more robust protection, you may want to pursue an irrevocable trust. Once assets are transferred into this type of trust, they are typically shielded from the beneficiary’s future creditors, lawsuits, or even divorce proceedings. If your children face careers with high liability risk (such as medicine, where doctors may face lawsuits) or if you are concerned about their spending habits, an irrevocable trust could be essential.

Naming beneficiaries strategically

Many retirement accounts and life insurance policies allow you to name a direct beneficiary, allowing these funds to pass outside of your will and bypass probate entirely. This is called a transfer-on-death or payable-on-death designation and is one of the simplest ways to help protect these assets.

However, naming a minor or an individual with special needs as a direct beneficiary can unfortunately create legal complications. For these situations, it may be ideal to name a properly drafted trust as the beneficiary instead. This ensures that the funds are managed by a responsible trustee and are distributed according to your specific rules rather than falling under court supervision.

Tax-efficient transfers

A significant drain on an inheritance is often unnecessary taxation. One powerful strategy for minimizing these is utilizing the annual gift tax exclusion. Each year, you can gift a certain amount (adjusted annually for inflation) to any number of individuals without incurring gift tax or affecting your lifetime estate tax exemption. By consistently gifting small amounts over many years, you may significantly reduce the size of your taxable estate while you are alive, potentially shrinking the potential tax burden on your heirs.

Another key component is understanding the step-up in basis rule for appreciated assets. Generally, when you transfer assets like stock or real estate to your heirs upon your death, the value for capital gains purposes is “stepped up” to the fair market value at the time of your death. This effectively erases capital gains taxes that would have been due had you sold the assets while alive, and it may save your heirs a substantial amount of money when they eventually sell them.

In short, protecting an inheritance is not a one-time task but an ongoing process. By carefully utilizing trusts, making smart beneficiary designations, or employing tax-efficient giving, you could help safeguard your wealth and provide more security for your loved ones. To seek further information on building a confident fiscal strategy for your family, speak with a financial professional.