When it comes to sharing your wealth, there may be no better time than the present.
“Many times, it’s better to give money or assets to your loved ones while you’re still around rather than wait until after you pass,” advises Hayden Adams, director of tax and financial planning at the Schwab Center for Financial Research.
In addition to the emotional lift of giving to those you care about, giving now can also be a savvy tax move for families with substantial wealth because both the present value and any potential future growth of the transferred assets are removed from your taxable estate.
It’s important to remember that although the IRS generally doesn’t care when you make a major gift, the timing can make a big difference to your heirs. Giving a smaller amount when your heirs need it and you're still alive can be more meaningful for everyone than waiting to pass on a larger amount after you're gone. What matters is what would work best for your family.
Just make sure you understand all of the rules.
Gift and estate tax: The basics
The IRS allows lifetime tax exclusion on gifts and estates up to a certain limit, which is adjusted yearly to keep pace with inflation.
For 2017, an individual’s combined lifetime exclusion from federal gift or estate taxes totals $5.49 million. If married, the joint exclusion is $10.98 million. (U.S. citizens also have an unlimited exemption from property they inherit from a spouse.)
You can use all or part of your gift and estate tax exclusion during your lifetime. Any portion left over can then be used by your heirs to reduce or eliminate estate taxes they might otherwise owe. That can be a big deal for your heirs, as the top federal estate tax rate currently stands at 39.6%. “If the inheritance your heirs receive is subject to the estate tax, your loved ones many not receive all that you had hoped they would,” explains Hayden.
Even if your gifts use up your entire exclusion, your loved ones could still come out ahead—they would get your largesse tax-free today and could take advantage of its potential for growth.
However, there are specific giving strategies you can use today that can reduce the size of your taxable estate and leave your gift and estate tax exclusion untouched. Here’s how to enjoy giving today and potentially save your family money down the line.
Take advantage of annual gift-giving limits to reduce estate taxes
There is an annual $14,000 tax break for gifts you make to individuals—also indexed to inflation—separate from the lifetime exclusion. The advantage of this strategy: Not a penny of your gift counts against your lifetime gift and estate tax exclusion. And because annual gifts reduce the size of your estate, they reduce the potential tax liability for your heirs.
You’re allowed to individually give that amount to as many people as you like. If married, you and your spouse may each give $14,000 to a particular individual, for a total annual gift of $28,000. For example, a married couple could give $28,000 to an adult child and $28,000 to each of their three grandchildren, for a total of $112,000. Even though you and your spouse would be combining both $14,000 exclusions, this strategy is called “gift splitting.” And although you won’t owe any additional taxes to the IRS, splitting gifts may still require you to file a gift tax return—Form 709—for the purpose of documentation.
Making a $14,000 annual gift can also be incredibly easy. Unless you and a spouse are gift splitting, you don’t need to file a gift tax return. Recipients typically owe no tax and aren’t required to file any special tax forms.
You can give more than $14,000, but know the rules
Let’s consider the following: Suppose you give two grandchildren $20,000 each this year, and you give a family friend $10,000. The gift to the friend doesn’t trigger any gift tax issues, as it’s within the $14,000 annual exclusion. But the gifts to the grandchildren exceed the exempt amount by $6,000 apiece and would require special care.
The amount that overran the $14,000 annual limit would be deducted from your lifetime exclusion. Unless you have already used up all of your lifetime exclusion, you won’t actually owe any tax on the gifts to the grandchildren. You will, however, need to let the IRS know that those gifts exceeded the annual limit by filing a gift tax return. In this example, your lifetime gift exclusion is reduced by a total of $12,000 ($6,000 for each grandchild).
Giving that is exempt from federal gift and estate tax
In addition to the $14,000 gift-giving strategy, there are other ways you can make gifts that reduce the size of your estate without eating into your lifetime gift and estate tax exclusion.
The IRS gives you a free pass when:
- You pay the medical bills for another individual.1
- You pay the tuition bills of a student.2
- You make a charitable contribution to an exempt organization.
There is no annual limit on the size of these gifts. As far as taxes go, it’s as if those weren’t gifts at all.
One important caveat when it comes to medical and tuition bill gifts, however: The money must go directly to the institutions, rather than to the patient or student you’re helping.
Giving to a 529 plan
If you wish to help fund a 529 college savings plan, the $14,000 annual gift limit comes back into play. But in this case, you’re allowed to bundle five years’ worth of $14,000 gift tax exemptions into an initial $70,000 contribution to one student’s 529. Bear in mind that any additional gifts to that individual during the next five years will put you over the annual giving limit, so your lifetime exclusion will be reduced by the additional amounts.
Also, if you die in the five years after you make the gift, a prorated amount of your gift will get tossed back into your estate, but only for tax purposes. The money you gave stays in the 529 account.
Your giving plan, going forward
The bottom line is that giving sooner might make more sense rather than waiting to bequeath your assets after you die. Hayden advises sitting down with a tax and estate professional to consider how a giving strategy fits in with your overall investment plan, and to determine whether it makes sense for you to give now or later.
“For many people gifting over their lifetime can be a great strategy, so long as they leave themselves enough to live on. With so much at stake, be sure to plan carefully with the help of a professional,” says Hayden.
1Medical care includes expenses incurred for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body, or for transportation primarily for and essential to medical care. Medical care also includes amounts paid for medical insurance on behalf of any individual.
2Does not include books, supplies, room and board, or other similar expenses that are not direct tuition costs.