5 Things to Consider Before Passing an Inheritance to Your Children

“So, for whom are you investing this aggressively?”

This is the unsettling question an elderly relative asked Jim, a 35-year-old single man, when he was discussing his investment portfolio over a cup of porridge upcountry during the holidays. 

The elderly man, while in awe of Jim’s success in real estate and the stock market, could not understand why Jim worked so hard amassing wealth when he was all alone; unmarried with no children. 

Perhaps it was his way of nudging him to get married - and as it turns out, the motivation to build wealth, for many people, has a strong element of giving oneself the opportunity to leave an inheritance to their heirs. 

The decision whether to leave an inheritance or not for your children can significantly impact your financial planning today. You may often hear some parents say that education is the only inheritance they can afford to give their children, and this too does come with a lot of financial disruptions for the parent. 

If you are planning to leave an inheritance for your heirs, you will have to realign your retirement plans, how much you save, what you invest in and even your post-retirement healthcare plans. 

To help you make sure your desire to leave behind some wealth for your children and grandchildren, we explore five critical personal finance considerations that are greatly impacted.

5 Things to Consider Before Passing an Inheritance to Your Children

Inheritance will typically be given to beneficiaries after retirement, death, or in the case of early inheritance, at least when the beneficiary is of legal age. With rising levels of life expectancy, and as a general practice, most people will give their children inheritance during their retirement years.  

1. Consider Your Income Needs

Begin by conducting a financial self-audit that maps out your income sources, expenses and savings. You should be able to establish your current income needs and then make an estimate of your income needs after retirement. 

One big mistake many retirees make is to give away all their life savings without considering what they will need to spend on themselves once they are no longer gainfully employed. 

You can utilise digital retirement calculators to compute a good estimate of how much you will need after retirement while also accounting for inflation. Then, you will be able to plan out how much you need to save today for yourself and towards your desire to leave an inheritance - separately. 

Away from your retirement fund, assessing the susceptibility of your investment portfolio to inflation, will give you a good picture of whether your illiquid investments can support your needs during retirement. 

Key Questions:

1. How much income will I need when I retire?
2. What will be my sources of income during retirement?
3. What do I need to do to achieve the target retirement income?
   

If you plan this out well, then you are able to tell how much you can spare for the inheritance kitty, where you need to put the inheritance money to grow, what investments can fund both objectives and so on.

2. Plan For Healthcare Needs

It is a lived experience in Kenya that a majority are one medical emergency away from financial ruin. This is as true for the middle class as it is for lower-income households across the country. 

Healthcare costs can become an even bigger burden post retirement due to the possibility of higher cost for longer-term care, expensive age-determined insurance premiums and the general fact that the older we get, the more susceptible we are to illnesses. 

As such, it is very important to be cognisant of the impact healthcare costs can have on your income-earning potential, savings and investments. And consequently put in place measure that will ensure your retirement savings, retirement kitty and other investments are not wiped out by medical costs. 

Some options to consider;

1. As an absolute minimum, signing yourself and loved ones up for the National Health Insurance Fund (NHIF) can help bring down the costs of most everyday ailments and hospitalisations 
   

2. Getting a private health insurance cover for your family will add to the protection NHIF gives and, depending on the limit, significantly reduce your off-pocket expense on a significant medical emergency 
   

3. Seriously consider signing up for long-term care health insurance for you and your spouse as you get into retirement age. This is a health care policy designed for the elderly that is also called seniors insurance policy by some insurers.
   
   Access to insurance may be limited in Kenya as one grows older, but there still are insurers with bespoke products for the elderly. Note that these policies will typically come with significantly higher premiums and more cover limitations than other policy types.
   

4. Consider a life assurance policy. In the unfortunate event that you lose your life, your beneficiaries will receive a payout that is free of tax which can technically act as a fom of inheritance. 

3. How Big Is Your Retirement Fund?

If you are planning on leaving behind an inheritance after your death, as many choose to do, then you want to make sure your retirement years do not eat into all your savings and investment income. 

Did you know, according to UN projections, the life expectancy for Kenyans in 2022 is 67.21 years? Thanks to a gradual improvement in access to healthcare, quality of life and technological advancement, the overall life expectancy in Kenya has been increasing at an average of 0.4% annually for the last 5 years.  

In the two decades between 2000 and 2020, WHO's statistics show that life expectancy rose by 21% or 11 years in low income countries such as Kenya. 

This means, there is a possibility that one might outlive a retirement fund based on current national life expectancy estimates. If this happens, you are likely to dip into funds set aside as your children's inheritance. 

How to avoid outliving your retirement fund

Retirement funds, whether employer-sponsored or individual accounts, generally come in two payout options. 

You contribute monthly to a fund until your chosen retirement age and the accumulated money plus interest is paid under either;

1. As pension plan where a percentage (usually one third) of the accumulated benefit is paid as a lump sum and the remaining two-thirds;

1. is paid as a regular income for life
2. can be withdrawn from the fund after a set minimum (typically 10 years)
   

2. The provident plan - where the total accumulated amount is paid as one single lump sum
   

While either option is great depending on your needs, the provident plan is particularly risky considering the abundance of stories of retirees burning through their lump sum payouts in just a few years after leaving employment. 

If you have a provident plan, consider using part of the lump sum to buy an immediate annuity that guarantees you a regular amount as income for as long as you live - much like the pension plan option. 

This annuity is a contract between an individual and an insurance company – where you pay an insurance company a lump sum of money. The insurance company, in turn, will pay you a regular, guaranteed income, according to the contract terms, for as long as you live. 

You can then invest the remaining amount to further grow your wealth and improve the chances of leaving a substantial inheritance to your heirs. 

Another practical option is to switch from a provident plan to a pension option if your policy contract allows that. 

Note that the amount you receive as a monthly annuity/pension will be dependent on how much you have saved in the fund and for how long you have been doing so before retirement. So it is very important that you start doing so early or if not, increase the size of your contributions to guarantee a monthly pension equivalent to estimated income needs post-retirement. 

You also have the option of working for longer than your initial retirement age to continue earning a full income and build a bigger retirement fund. 
It is also very possible to invest all your lump sum from a provident plan in a successful venture and multiply it, guaranteeing an even bigger inheritance to your loved ones. It is, however, a highly risky option. 

4. Consider the Tax Implications 

Like most change of asset ownership scenarios, tax is unavoidable. But there are legal ways to protect your child/children's nest egg from steep tax fees. 

In Kenya, inherited assets such as property are subject to a capital gains tax (CGT), which is a final tax. 

This is the tax levied on the transfer of property situated in Kenya and acquired, on or before January 2015. It's declared and paid by the transferor of the property at the current tax rate of 5% of the net gain; once paid, there's no further taxation.

Other inherited assets such as shares, bonds, and more have set tax provisions, where applicable.

Earnings on bank fixed deposits, shares, bonds and real estate, for instance, are all taxable save for the exempt persons. Gains below Ksh30,000 are exempted from CGT.

Another thing to consider is whether the appreciation on pension contributions to your scheme will be taxed. That is the compound interest earned throughout the life of the policy. If your scheme is not registered, the gains on the pension contributions will be taxed. 

If you are leaving your loved one an asset such as land, which is quite popular in Kenya, note that in addition to the several fees such as stamp duty, legal fees, surveyor fees and other professional fees, the transaction is subject to the 5% CGT. 

Given the Kenyan tax regime, it is advisable to consult a qualified tax consultant well versed in the law of succession for the best advice on how to shield your heirs from hefty taxes that may water down the value of the inheritance or make it difficult for them to make a transfer to their name, such as land. 

5. Consider Possible Investments 

You ideally want to leave an inheritance that will not only benefit your immediate children, but also last to be inherited by the generations to follow. 

This is typically true for individuals with large estates and a well diversified portfolio. You want an investment portfolio that grows in order to generate income while also preserving capital  - that is a conservative investment strategy that protects the monetary value of the asset and prevents loss including from inflation. 

This strategy, to make sure your investments benefit even your grandchildren, is also contingent on the inheritors only withdrawing the profits and maintaining the principal amount. So you might want to make sure your heirs are investment savvy and can see this through. 

Wrapping Up

Handle your business first before anyone else’s - you are only able to take care of your heirs when you already have taken care of yourself. This might sound selfish to some, but it is really the only way to come close to achieving your inheritance desire. 

Regardless of the industry sector, you’re in or the type of career you have, you can’t give more than you have.

 So, if you would like to leave something behind for your children or grandchildren, understanding how it will impact much of your financial planning, is a step in the right direction.