Wealth Transfers: The Benefit Of Annual Gifts by Anne Bucciarelli, Ashley E. Velategui – Alliance Bernstein

Many wealthy US investors want to give substantial sums to family during their lifetime, while preserving their flexibility, in case they need the money later. That’s fine: Large annual gifts can go a long way to helping your children get started on their careers, buy homes, or simply live more comfortably. Here are several tax-efficient strategies to consider.

Using the Educational/Medical Exclusion

Individuals can pay an unlimited amount for someone else’s tuition or healthcare directly to the education or healthcare provider, without using up any of the donor’s annual exclusion or lifetime applicable exclusions from gift or generation-skipping transfer taxes.

Maximizing of Annual Exclusion Gifts

The annual exclusion from transfer tax is currently $14,000 a year, adjusted for inflation, for an individual and $28,000 for married couples, and you can make these gifts to an unlimited number of recipients each year. If you have five children, you could give them a total of $140,000 a year; with inflation, that could amount to $1.6 million over a decade. The annual exclusion is in addition to the current $5.45 million lifetime exclusion on gifts made during your lifetime or at death.

Use it, or lose it: Failure to make annual exclusion gifts during a calendar year represents a wasted opportunity. If you have potential surplus capital (money you won’t need to support your own lifestyle) that you want to give to your children, it generally makes sense to make the most of annual exclusion gifts, even if your estate is unlikely to be subject to estate tax at death.

Note, however, that outright transfers to minor children may result in their receiving too much money at a relatively young age, such as 21. It is generally worth consulting with professional advisors about how best to use annual exclusion transfers.

Using IDGTs to Maximize Gifts

If the recipient doesn’t need the money for immediate consumption, you can make annual exclusion gifts to an intentionally defective grantor trust, or IDGT. With an IDGT, the trust assets are excluded from the donor’s estate for estate tax purposes, but the income generated is included in the donor’s income for income tax purposes. Because the donor is legally responsible for paying the income tax on the trust income, the donor can further reduce his estate while letting the trust assets grow tax-free for the eventual recipient.

We estimate that in typical markets, annual exclusion gifts to an IDGT for one beneficiary can transfer more than $400,000 in inflation-adjusted dollars over 20 years; over 30 years, that figure would grow to about $825,000, as the Display shows. About $180,000 of the total would come from the donor paying income taxes on the trust income.

Annual Gifts

Annual Gifts

A single lifetime gift to an IDGT, using a portion of the donor’s $5.45 million applicable lifetime exclusion amount, can allow a donor to transfer significant wealth because all the future appreciation on the gift and the future income taxes will be outside the donor’s estate. The donor could also use a portion of his lifetime applicable exclusion to make a single lifetime gift to an IDGT to benefit his grandchildren and more remote descendants, without incurring transfer tax.

The views expressed herein do not constitute, and should not be considered to be, legal or tax advice. The tax rules are complicated, and their impact on a particular individual may differ depending on the individual’s specific circumstances. Please consult with your legal or tax advisor regarding your specific situation.

The Bernstein Wealth Forecasting System uses a Monte Carlo model that simulates 10,000 plausible paths of return for each asset class and inflation and produces a probability distribution of outcomes. The model does not draw randomly from a set of historical returns to produce estimates for the future. Instead, the forecasts (1) are based on the building blocks of asset returns, such as inflation, yields, yield spreads, stock earnings and price multiples; (2) incorporate the linkages that exist among the returns of various asset classes; (3) take into account current market conditions at the beginning of the analysis; and (4) factor in a reasonable degree of randomness and unpredictability.