As people are living longer, often well into their nineties, the way wealth is transferred to the next generation is starting to shift. The paradigm of waiting to pass family wealth to children on the second parent’s death is being reconsidered because parents are living longer and children have a greater need for assistance.
Is it optimal to pass on a legacy to the next generation at a time when a child is already well established (maybe even retired) and has children and possibly grandchildren of his or her own? Instead, it may be preferable and more rewarding as well to pass wealth to children earlier and be able to see the “fruits of your labour” enjoyed, while balancing the desire to have children succeed independently.
In a previous blog, “The New Normal: Assisting a Child with Buying a Home”, we discussed an increase in parents helping children to purchase their first home and considerations that must be taken into account, one of which being how to equalize such gifts or loans among other children.
Parents may wish to help their children purchase a home or to gift generally during their lifetime. If parents are concerned about loaning or gifting unequally among children, one solution is to include a “hotchpot” clause in their wills.
“Hotchpot” literally means a mixture of property. After the parent’s death (or the surviving parent’s death), the estate trustees would take into account the amounts each child already received to calculate the final amount due to each child under the terms of the parent’s will. One might view this as an equalization of assets given both during lifetime and on death.
If a child has received an advance from a parent or owes a debt to a parent that the parent would like to have taken into account when dividing the residue of the estate among all children, then a “hotchpot” clause should be included in his or her will.
Alternately, a parent may consider forgiving a loan, subject to tax considerations. In including an equalization provision, a parent can give without any concern of treating children unequally at the end of the day. The equalization provision would allow a parent to address major amounts gifted to one or more children during the parent’s lifetime and ensure that all children receive the same benefit on the parent’s death.
How to structure the gift or loan to a child should also be considered in light of family law considerations, to ensure protection on matrimonial breakdown between a child and his or her spouse. Parents should get legal advice on how best to structure the transaction, whether by way of gift or loan and how to document it properly.
The estate trustee will need to be able to clearly determine whether an advance was a gift or a loan and, with respect to a gift, whether it will be taken into account by way of hotchpot, or, with respect to a loan, whether it will be taken into account by way of hotchpot (and set-off against a share) or will be forgiven. Proper documentation of the structure of the gift or loan, and the parent’s intention on how to treat it on death, is paramount. In many cases, unfortunately, these intentions are not well documented.
Individuals who are subject to U.S. gift and estate tax may wish to take advantage of the current high exemption amount applicable, which is currently $11.58 million USD. In addition to this lifetime exemption, a U.S. person is entitled to an annual exclusion of $15,000 USD for gifts made to anyone other than a spouse, including children. Anything over and above the annual exclusion would be considered to be part of the lifetime exclusion if certain tax filings are made.
The current American federal unified estate and gift tax exemption amount is set to revert to its original $5 million USD amount indexed for inflation in 2026 (although it may change sooner if there is a change in government). The IRS has confirmed that there will not be a “clawback” for gifts made under the increased estate and gift tax exclusion. In light of this, now may be an appropriate time for U.S. persons to consider giving significant gifts.
In considering transitioning wealth and providing financial assistance to a child or children during a parent’s lifetime, it is important to get professional advice on how best to structure and document any gifts or loans and how to ensure that they fit into one’s overall estate and giving plans.
— Marly Peikes