“In the interest of fairness, I would like to give my sister’s two children, my niece and nephew, what would have been my sister’s half of the inheritance had she lived.”

“In the interest of fairness, I would like to give my sister’s two children, my niece and nephew, what would have been my sister’s half of the inheritance had she lived.” – MarketWatch photo illustration/iStockphoto

Dear Quentin,

I will inherit a substantial amount — hundreds of thousands of dollars — from my father. This means that my only sibling, my deceased sister, is effectively cut out of the will because her children won’t inherit what would have been her half, as was stated within his previous will before she died.

In the interest of fairness, I would like to give my sister’s two children, my niece and nephew, what would have been my sister’s half of the inheritance had she lived. He deliberately and hurtfully omitted all of his grandchildren from his will in writing. How can I best do this in such a way that nobody is penalized from gift taxes and other costs?

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Should I tell him I’m doing this ahead of time, or wait until he has passed away?

The Good Aunt

Related: ‘I got seriously burned’: My financial adviser took me for lunch, bought my kids gifts — and had me invest $500,000 in annuities. What should I do?

“Any obligations to Uncle Sam will largely depend on whether you want to give them a big lump sum, or parse it out over time.”

“Any obligations to Uncle Sam will largely depend on whether you want to give them a big lump sum, or parse it out over time.” – MarketWatch illustration

Dear Aunt,

Grandpa wasn’t messing around. He clearly had his reasons for omitting your sister’s children from his will, assuming that he took the time to mention them by name. With this knowledge, proceed with caution lest he do the same to you. If you challenged him, he could end up leaving his estate to the dogs and cats at home (worthy as they are).

The good news is that you believe your father should leave half of his estate to his two grandchildren in lieu of your sister, and you do have the power to right what you perceive to be wrong. It would have been more meaningful if it came from him and, as you suggest, he probably could have done so without them incurring inheritance taxes.

To funnel your niece and nephew the money after you inherit it, the best way might be to break it up into annual gifts under the federal gift-tax exclusion of $18,000. That means you can give up to $18,000 each to your niece and nephew per year, and could even give that amount to each of their spouses and children, if they had any.

Married couples, if they file jointly, have a $36,000 annual gift-tax exclusion; both parties must consent to the gift and file joint tax returns. (You can read more on that here.) No inheritance taxes would be due on these amounts, and no paperwork would need to be filed. But if you give more than that, you’ll have to file tax forms that will count against your lifetime federal and applicable state estate-tax thresholds.

“The lifetime estate- and gift-tax exemption is scheduled to be reduced by half in 2026 and adjusted for inflation,” according to Kiplinger. “Estimates suggest a reduction close to about $7 million or less. If you are wealthy and have a large estate, gifts given in 2026 or beyond (if the limit sunsets as scheduled) could be subject to up to 40% gift tax.”

Education and medical expenses

Even before you get an inheritance, if you have money to do so now, you can open up 529 plans for their education (or that of their children) knowing that it will eventually count toward the money coming from their grandfather through you. “You would be able to bunch five years’ worth of gifts, or as much as $90,000 into a single contribution to help fund their future education,” said Martin Schamis, vice president and head of wealth planning at Janney Montgomery Scott.

You can give them perhaps an even bigger gift by opening a custodial account to trade stocks, bonds and exchange-traded funds. Through that, they can learn the magical powers of compounding. If you invested a few thousand dollars in an index fund, which are basically mutual funds that track the performance of stock indexes, and contributed a couple of hundred dollars a month, your niece and nephew could have a nest egg worth tens of thousands of dollars in a decade.

Cynthia D. Brittain, partner at Karlin & Peebles, LLP in Los Angeles, said you could also just pay tuition and expenses directly to their university or private school and it would not count as a gift, and deduct it from their “inheritance” later on. “Higher education payments do not trigger any type of gift tax reporting,” she says. “The same applies for medical expenses as long as payments are made directly to the medical facility, if that is relevant or applicable.”

For those who are leaving large sums of money to their family: The federal estate-tax exemption amount currently stands at $13.61 million per individual or double that for married couples, and is scheduled to levels prior to the 2017 Tax Cuts and Jobs Act, which would be an estimated $7 million per individual adjusted for inflation. The maximum federal estate-tax rate will remain 40%.

Currently, only six states — Maryland, Nebraska, Kentucky, New Jersey, Pennsylvania and Iowa (where the inheritance tax will phase out in 2025) — impose an inheritance tax. Maryland also charges an inheritance and estate tax. Pennsylvania, however, is the only state to charge “lineal heirs” (children and grandchildren) and imposes a 4.5% inheritance tax.

So any obligations to Uncle Sam will largely depend on whether you want to give them a big lump sum, or parse it out over time. But with a few hundred thousand dollars coming down the pike — hopefully later rather than sooner — it should be possible to carry out your wishes in a tax-advantaged way. There’s only so much control we can exercise over our estate after we’re gone.

P.S. “The Good Aunt” sobriquet is my gift to you.

Previous columns by Quentin Fottrell:

My friend, 78, has $500K saved and owns a home with his girlfriend of 20 years. Should he split his estate with his daughter?

‘I received accolades’: I reported a toxic coworker who threatened me — and I was terminated after 7 years of stellar employment. What can I do?

I was a stockbroker in the 1980s and always kept my money separate from my husband’s. Is such self-protection justified?

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