Is It a Good Idea to Make Lifetime Gifts?

A powerful estate planning strategy

03.21.2016 - Gail E. Cohen

Spreading gifts throughout your lifetime is a powerful strategy which could reduce the amount ultimately paid in estate taxes. Our Fiduciary Trust senior leaders discuss how lifetime gifting can reduce estate taxes. They also offer strategies to make the most of today’s transfer tax environment.

Q. What are the current federal estate and gift tax rates and exemptions?

GAIL: The amount that can be passed federally tax free to beneficiaries—either through lifetime gifts or under a will at death—is set at $5.45 million ($10.90 million for married couples) in 2016. This exemption amount increases at the rate of inflation each year. The federal tax rate for amounts transferred above the exemption limit is 40%.

THERESA: In addition to the lifetime exemption, there is an annual gift tax exemption amount which allows you to make annual gifts up to $14,000 to any number of beneficiaries tax free, without reducing the transfer tax exemption amount.

Q. Why do you recommend lifetime gifting for families?

THERESA: Gifts are the bedrock of estate planning. Because we are living longer lives, gifts often help beneficiaries when they need it most. Many estates pass to children at a time when they themselves are retiring, whereas lifetime gifts may help in paying for family living, housing and education expenses. Another advantage of gifts is that they may allow children to become familiar with the investment process along the way, enabling them to better handle a later inheritance.

GAIL: There are also several valid economic reasons to make lifetime gifts versus waiting to pass assets to beneficiaries under a will. For one, allowing investment growth to take place in the hands of beneficiaries is often very advantageous from a tax standpoint. With today’s 40% federal estate tax on assets transferred above the exemption, removing any future appreciation from the estate early can mean significant potential tax savings for heirs down the road.

Of course, in today’s tax environment, it is important to consider the income tax implications of any strategy. While lifetime gifts do remove the asset from an individual’s taxable estate, the beneficiary takes the donor’s cost basis. If the property to be gifted consists of low cost basis, highlyappreciated assets, it might be more advantageous for the donor to hold onto those assets, so as to obtain the step-up in basis to date of death value in order to minimize any capital gains tax that would be due when those assets are sold. Careful consideration of both the estate and income tax consequences of any proposed gift is critical.

THERESA: For those clients who do decide that lifetime gifting meets their overall objectives, we often recommend making gifts in trust. Trusts offer asset protection benefits, assets can shelter for multiple generations, and may provide an opportunity to leverage gifts by allowing the donor to pay the trust’s income tax. For those clients who are concerned about future income tax flexibility, certain provisions, such as powers of appointment, can be built into the trust agreement so as to allow those clients to respond to long-term tax planning needs.

Q. How can making gifts help reduce estate taxes at the state level?

GAIL: The impact of state estate and inheritance taxes can often be overlooked because not every state imposes them. However, 19 states including New York, New Jersey, Connecticut, Maine and Rhode Island, plus the District of Columbia levy a state estate tax or inheritance tax on top of the federal estate tax, and these taxes can be as high as 20% in some states.

Furthermore, many of these states have much lower estate tax exemption amounts. For example, the exemption in New York is $3.125 million.1 Therefore, residents who die in 2016 with a $5.45 million estate will pay no federal estate taxes, but their estates will be subject to $325,000 in New York state estate tax.

THERESA: The good news is that making lifetime gifts may reduce or eliminate state estate taxes. Most states impose an estate tax only on property owned at death. Thus, property transferred out of the estate during life in the form of a gift will not be subject to state estate tax.2 Also, since no state other than Connecticut imposes a gift tax, the transfer will generally not incur state level gift tax.

Q. What can be done to make the most of today’s transfer tax environment?

THERESA: If a married couple believes they will have more than $10.90 million in their combined estates, they might consider strategies to reduce or freeze the value of their estates for estate tax purposes. For example, Grantor Retained Annuity Trusts (GRATs) can be used as part of an estate plan to help families transfer asset appreciation to beneficiaries estate and gift tax free. We also recommend that families take advantage of the $14,000 annual taxfree gift allowance I mentioned earlier. This allows individuals to gift up to $14,000 per year to as many beneficiaries as they would like without reducing their transfer tax exemption amount.

GAIL: Gift tax returns are required to be filed by the donor by April 15 of the year following the gift. If family members have already made lifetime gifts up to the federal exemption limit, they should consider topping off that gift every year since the limit is adjusted upward for inflation annually. For example, if a family member gifted the $5.43 million individual tax-free limit in 2015, he or she can add another $20,000 tax free to that gift to meet 2016’s $5.45 million exemption, and so on for future years.

Q. How can families best structure gifts to grandchildren?

GAIL: The generation-skipping transfer (GST) tax exemption has also been set at $5.45 million for 2016. We often recommend family members use their GST tax exemption to establish Delaware dynasty trusts that can last in perpetuity, ensuring that distributions to grandchildren and other remote descendants are not subject to any transfer taxes in the future.

THERESA: It is important to note that unlike gift and estate tax, the GST tax exemption must be used by each spouse during his or her lifetime or death. It cannot be transferred over to the surviving spouse.

Q. What is the first step that families should take today?

GAIL: It’s a good idea for families to step back and take a look at all of their assets, how they are held and who will receive them at death. This review should involve not only wills and trusts, but also other documents that may govern the disposition of substantial amounts of property at death. These include pension, IRA and life insurance beneficiary designations, real property deeds and the title of investment and bank accounts.

THERESA: Regardless of the financial and non-financial benefits of lifetime gifts, we always stress that individuals need to take care of themselves first, and make sure their assets will support their needs through the rest of their own lives. To review your estate plan and discuss planning opportunities specific to your family’s needs, feel free to contact your trusted advisor or your Fiduciary Trust representative.

1. The NY State exemption is $3.125 million for decedents dying between April 1, 2015 and March 31, 2016. That amount will increase again on April 1, 2016 to $4,187,500 and on April 1, 2017 to $5.25 million. Finally, on January 1, 2019, it will be tied to the federal exemption.

Fiduciary Trust Company International and subsidiaries (doing business as Fiduciary Trust International), Fiduciary Trust Company of Canada and FTCI (Cayman) Ltd. are part of the Franklin Templeton Investments family of companies.

This communication is intended solely to provide general information. The information and opinions stated are as of March 1, 2016, unless otherwise noted, and may change without notice. The information and opinions do not represent a complete analysis of every material fact. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.

IRS Circular 230 Notice: Pursuant to relevant U.S. Treasury regulations, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. You should seek advice based on your particular circumstances from your tax advisor.

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