Give It Away Now Or Pay A Hefty Tax Later
-This article provides tools to determine when you have enough to start giving and how to avoid paying a large estate tax at death by holding onto too many assets.
The lifetime exemption from the unified gift and estate tax is higher now than it will ever be. 30 years ago the tax was 55% but the exemption was only $600,000. Now, our estate and gift tax rate is 40% but the exemption is a whopping $12.92M. This is all going away on December 31, 2025, which is less than three years from now. Virtually all of the experts in the filed agree that we are in a unique and expiring planning window between now and then, with an emphasis on now since Congress can change the exemption at any point before 2025.
TO GIFT OR NOT TO GIFT?
Questions to ask yourself or your advisors in order to determine your gifting capacity:
1)What is your financial need?
2)What is your life expectancy?
3)What rate of growth can you assume?
4)What rate of inflation can you assume?
There are lots of ways to calculate this, but leaving it to your professionals is best. If you want a back of napkin thumb sketch you can use the “FIRE” method which is short for Financial Independence, Retire Early (further explained on Investopia website https://www.investopedia.com/terms/f/financial-independence-retire-early-fire.asp) which advises you have 25x your annual spending set aside. Or you may use The Capital Group guidance which determines your retirement needs by taking what you have and assuming roughly 2% inflation and allowing 3% from today’s spending times 33 years. (further detail found on their website https://www.capitalgroup.com/individual/planning/tools/retirement-planning-calculator.htm)
Now, let’s say you determine you can afford to gift because your financial needs are met by your current assets and income derived therefrom. In that case, you may begin to look at estate tax planning and long term planning for tax efficiency.
You can consider some of the following common gifting methods, each offering a unique benefit.
-GRATs (Grantor Retained Annuity Trust)
-Sale to a Defective Grantor Trust (a grantor trust means that the person giving pays the tax on the trust’s assets)
-ROTH IRA conversions
-Transferring cash or other assets immediately to the beneficiary (through a trust or directly)
-Charitable Remainder Trusts
-Intra Family Loans (taking a note back)
Before pulling the trigger, each person should enlist their advisors to make a determination of which gifting vehicles work best in light of family needs, the donor’s needs, asset type, basis of assets, donor’s need for income or ability to borrow, and other important considerations.
While it’s true that interest rates have changed over the last year, but historically they are still low. When put in context, the increase in rates of late is not sufficient enough to dismiss certain gifting strategies off hand.
THE TAKE-AWAY
Giving away a dollar today can be worth four or five dollars to the recipient down the road. This is predominately due to the power of tax-free growth and compounding. Setting aside individualized circumstances that may lend themselves to extraordinary growth of personal investments, this visual of the S & P 500 index from the 1920s to 2023 drives home the point that growth inevitably occurs over time.
The other side of the coin when discussing gifting is analyzing what early access to money can do for a beneficiary? I am a keen proponent of not “spoiling the child”, but done in the right way, with the right conditions and trustee powers in place, transferring wealth to a child early can exponentially increase their wealth over time. A simple example of this is their ability to buy a real property 10 years earlier due to access to a down payment can compound the value of the gift in that they have ten years of growth of that asset.
It is never to early to start the long-term estate tax planning conversation with a professional. There is more to estate planning than avoiding probate and enlisting a knowledgeable estate planning earlier in your planning can provide unique insight as to the long term impact of your family and financial decisions.
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