If I am 80 years old and want to invest $300,000 in a trust for my grandchildren, should I invest this money in mutual funds, indexes, ETFs, or something else?
I am 80 years old and have 15 grandchildren. I have about $300,000 that I will put in an irrevocable trust for my grandchildren. The beneficiaries range in age from 4 to 28. The distribution will be based on education, health and welfare. The exact amount distributed will be up to the trustee.
Given at least a seven-year time horizon, should I invest this money: in mutual funds, indexes, ETFs, or something else?
A detailed analysis may reveal other important factors for your gifting goals, but it sounds like ETFs may be your best option. ETF’s are usually more tax efficient. Mutual funds usually have a some realized gains annually in appreciating markets. (This varies from fund to fund and past distributions can be looked up on mutual fund websites.)
Mutual funds do have the advantage of auto reinvesting dividends (and realized distributions although gains are taxable) back into the fund saving trading fees. Trading fees for your starting account of $300K may not be significant, but a pitfall to watch out for if any of your heirs might leave the money invested over a long time.
Example 2% in dividends from $20,000 in ETFs/Mutual Funds is $400. So a trading fee of $4.95 is not a big deal but if you have 5 ETFs that is $24.75 or 6.18% of your gain or you have $400 a year accumulating in cash that is not participating in the markets. The lost compounding effect is important over time.
I would suggest @5 different ETF index exposures for diversification and rebalancing purposes that can be carried out by your individual heirs or trustee(s) assuming some won’t liquidate at the 7-year mark or simply leave the assets alone. You might DIY your allocation, but consider a planner who does hourly/small project fees, is inexpensive and will point you to low cost and a properly mixed set of ETFs.
I do want to ask why an Irrevocable trust? There are many legitimate reasons to use that tool, but a revocable trust that becomes irrevocable at your death could get a step in in basis, assuming you aren’t already utilizing your $5.5 Million Estate Tax exception in other ways. ETFs are generally going to get more benefit from a step up in basis.
For Example: $300,000 ETF Trust that earns 5% appreciation and 2% dividends. The 5% appreciation by itself for 7 years grows the fund to $422,130 for a $122,130 taxable gain. Without a basis step up at 15% that is $18,319 in net taxes. But with a basis step up that tax is avoided saving each heir $1,221. ($18,319/15) This is equivalent to almost another year of appreciation at over 4.5%
The dividends will be taxable in any case. But they will make the tax savings even higher if you pay the tax each year on dividends and reinvest the remainder. If you want the more complicated calculation feel free to contact me. A free consultation with a planner or estate attorney is worth your time if you haven’t done so.
I trust that your grandchildren will enjoy and appreciate your generousity!
David Nash, CFA, CFP®
First of all congratulations on your savings and also being proactive in your estate planning. Assuming that you are splitting the money equally that comes to $20,000 per grandchild.
Risk and costs are two important things to look at in this scenario. While buying individual stocks may provide the most upside, at $20,000 it may be difficult to buy enough stocks to create diversification once commisions for each trade are factored in.
In this instance it makes sense to go the lowest cost route of ETF's to provide enough diversification at a reasonable cost. You may also be able to supplement a stock or two with the ETF's to provide some additional upside if it fits within the parameters of that particular beneficiary.
This is very thoughtful of you. As for where to invest it I don't really think it matters where as much as how. The reality is you can get an almost identical experience investing in any of the things you mentioned. An index is not a stand alone thing you can invest in as you alluded to rather you can get access to index like investing in ETF's or Mutual Funds. The fees don't change much and both are extremely liquid. I think the more appropriate thing to figure out is level of risk, volatility, return you are looking for with these dollars and work with someone to craft a carefully executed strategy. Then the decision becomes real easy as to which vehicles are best to help implement.
We would love to be able to help you! However, to get started on the right foot, we have many ?’s to ask you first. We work very much like a doctor would. Keep in mind you just don’t walk into the Doc’s office and immediately get a prescription.
In fact we always say that prescription without diagnosis is malpractice.
So let’s get started…..
ETF's and Funds are both great options......What is your risk tolerance, given the fact you are 80 years old.....Depending upon your risk, maybe you consider a fixed annuity as well.
What if we did a Joint Lifetime Income Annuity with you and each of the granchildren? By doing a Joint and Lifetime Income annuity, we can set it up so you can leave each of your grandchildren a lifetime gift, for thier respecitve lifetimes.
We can design it that each year, money will be sent to them on thier birthday in your name. This will pay them for there life.... and thats a long time.
We can talk more, and show you how this works...... Give me a call.
Brett M. Sause, LUTCF®, LTCP®, CLTC®, RFC®, LACP®, FSCP®
Principal & CEO