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Investing, Estate Planning and Your Heirs

The money you plan to pass on as an inheritance needs to be invested differently

Who are you investing for? It sounds like an easy question, but the answer becomes more complicated when you factor in estate planning. If you expect to have more than enough money to fund your retirement, then you should be investing that surplus portion of your portfolio differently than you are the rest of your nest egg.

Many individuals and couples who've accumulated large estates won't spend it all before they die, despite my entreaties. After all, most people who've built up sizable savings have done so the old-fashioned way, by living modestly. These same people are unlikely to become big spenders suddenly in their later years.

You need to consider how your estate should be passed on after your death. A will is an essential starting point. Rare is the family where all children and other heirs are in fine financial form, and this may influence how an inheritance is received. For example, giving a spendthrift child an inheritance outright may do more harm than good. Trusts can also come in handy as you plan your bequests.

Yet while estate planning tends to emphasize matters that arise after death, you should also consider whether the way your money is invested while you're alive takes into account the age of those who are most likely to receive it later on. All too often, retirees invest money that's likely to be passed on to younger family members — children, grandchildren, nieces, nephews and so on — the same way they invest money that they're going to need for retirement. So the money might be invested in Treasury bonds and other income-producing securities.

But shouldn't you be investing this money more like a 45-year-old (your child, for example) or a 20-year-old (your grandchild)? The answer is yes. In effect, you should invest more aggressively that portion of your wealth that's likely to be passed on to heirs, emphasizing growth investments rather than income-producing securities. 

Should you consider opening a separate account? >>

Separate account? If this description fits your situation, you may want to set up an entirely different investment account to separate the money you expect to need from the money that's likely to be passed down. This may simplify your investing, but it's not essential. Instead, you can simply change your overall investment diversification to increase the percentage you allocate to investments with strong long-term growth potential. 

Tax matters. The tax rules favor buying and holding individual stock investments, since taxes aren't due until the stocks are sold. Those who inherit stocks receive the so-called stepped-up basis, which is usually the cost basis as of the benefactor's date of death. For example, someone inherits stock that had a cost basis of $4,000. But the date-of-death value of the shares is $10,000, which becomes the cost basis for the heir. Thus, passing on low-cost-basis stock can be very advantageous to your heirs.

Preferred investments. If you inherited low-basis stocks from your parents or other family members, chances are they were shares of well-known blue chip companies. That was wise investment and estate planning. Using individual stocks for the portion of your investments that will be earmarked for inheritance is still a good thing to do, but you might also consider exchange-traded funds (ETFs) that invest in blue chip and other stock sectors like small-company and foreign stocks. Many ETFs are designed to pass on little if any capital gains. So as long as they're held (and they have gains), you receive the same tax benefits as holding individual stocks.

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