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A Primer for Strategically Gifting Assets

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Although the federal estate tax exemption amount has increased to $5.49 million this year, that doesn’t mean clients can forget about gift and estate tax management. With 20 states imposing their own estate or inheritance tax, having a plan for strategically gifting assets can help clients continue to maximize the amount of money they pass to their beneficiaries and minimize the amount of taxes they have to pay.

But what’s the best way to transfer assets to the next generation? The following strategies range from the simple to the more complex.

Take Advantage of the Annual Gift Tax Exclusion

The annual gift tax exclusion allows clients to gift $14,000 per year (in 2017) to as many beneficiaries as they choose, without affecting their federal estate tax exclusion amount. For example: 

  • If your client has three children, he could make a gift to each of them, for a total of $42,000.
  • A married couple can double that amount.
  • Clients who are also grandparents can also make gifts to their grandchildren.

As you can see, these gifts can add up, with no tax consequences. But be aware: If a client gifts more than the annual exclusion amount to a single beneficiary, the excess will be subtracted from the donor’s applicable estate tax exclusion amount, reducing the threshold at which he or she will owe estate taxes. (If gift tax becomes due, it is generally owed by the donor.)

The $14,000 annual gift tax exclusion can be used outright or as part of more complex strategies designed to minimize the gift value and maximize the use of the estate tax exemption.

A Traditional Strategy: The ILIT

With the irrevocable life insurance trust (ILIT), your client can use the annual gift tax exclusion to purchase a life insurance policy, whose value will be excluded from his or her taxable estate. This traditional strategy remains a solid technique for using annual exclusion gifts and providing wealth replacement for the client’s family. The trust, as the recipient of the tax-free insurance proceeds, can direct how the funds will be used for the family’s benefit.

Let’s take Deborah, a high-net-worth client facing estate tax issues. She funds the trust with a $7 million universal life insurance policy. 

  • The trustee of the ILIT is the policyowner.
  • The insured is Deborah.
  • The trust, benefiting her four children, is the policy beneficiary.

Deborah can gift $56,000 per year ($14,000 for each of the four trust beneficiaries). The children will each receive a Crummey notice, giving them the option to take a distribution of the $14,000 gift. They will elect not to take the gift, making the funds available for the trustee to pay the insurance premium.

When Deborah passes away, the $7 million death benefit will go to her beneficiaries, outside of her taxable estate. The proceeds from the insurance policy can be held in the trust and distributed per Deborah’s wishes. ILIT assets cannot be used to pay estate settlement costs or estate tax liabilities. The ILIT can, however, contain a provision that will allow it to lend money to Deborah’s estate, or it can purchase assets from her estate to provide liquidity to the estate.

With this strategy, Deborah can gift $7 million tax-free to her children and still reserve her lifetime estate tax exclusion. She is also able to remove $56,000 per year from her estate, tax-free, by using her annual gift exclusion to fund the insurance premiums.

A More Complex Strategy: Split-Interest Gifting

Another route is to help your client create a discounted gift through split-interest gifting.

Grantor-retained annuity trust (GRAT). A GRAT—an irrevocable trust with a split interest—is a popular planning technique that can offer a significant reduction in the gift tax value of transferred assets.

For example, Deborah wants to gift more than her annual exclusion amount and minimize the gift tax value of transferred assets, so she establishes a GRAT. She will receive an annual income from the trust based on a withdrawal rate established by the IRS for a term of years. At the term’s end, the remainder will go to the trust beneficiaries (i.e., her children). For transfer tax valuation purposes, the taxable gift amount is the fair market value of the property transferred minus the value of the grantor’s retained annuity interest.

If the trust is drafted properly, the IRS assumes that the trust assets will produce a return equal to the Section 7520 rate applicable to the month of transfer and that any property remaining in the trust at the end of the GRAT term will pass to the beneficiaries at the trust’s termination. If the GRAT assets produce a return greater than the 7520 rate (or actuarial value at the date of trust funding), the appreciated value is also transferred to the beneficiaries without further gift tax consequences.

The actuarial value of the remainder interest passing to the beneficiaries of the GRAT upon its termination is considered a gift subject to gift tax. A “zeroed out” GRAT is structured so that the retained annuity’s actuarial value is almost equal to the value of the property transferred, resulting in little gift tax consequence and making this an effective tool for a low-interest-rate environment.

  • If Deborah lives longer than the term of the income, nothing will be included in her estate upon her death.
  • If she dies during the term, the full value of the trust is included in her estate.

Charitable lead trust (CLT). Trusts can also be used to help philanthropic clients give to charity while shifting assets to their beneficiaries and minimizing taxes. With a CLT, the charitable lead beneficiary receives the income from the trust during the trust’s term; the noncharitable beneficiaries receive the remaining trust assets after the term has expired.

For clients seeking a significant charitable income tax deduction in the year the trust is funded, a grantor CLT would be most suitable, as it is drafted such that all income and deductions pass through the trust to the donor. The present value of the payments to charity at the time the CLT is created provides a charitable income tax deduction. Once the trust term ends, the remaining trust assets are transferred to the beneficiaries, removing them from the donor’s estate.

In a low-rate environment, this technique is especially useful, as the lower rate results in a higher present-value calculation for the charity. If the rate of return on the trust assets is higher than the IRS rate, the principal of the trust can remain intact for the noncharitable beneficiaries while still qualifying the client for a charitable deduction and removing assets from the estate.

Adhere to the Annual Exclusion Rules

With proactive planning, there are many ways to help ease the effect of estate tax on your high-net-worth clients. But it’s important to note that annual exclusion gifts—whether made outright or used as part of another strategy—are associated with a specific beneficiary. For instance, if your client makes an outright gift to a child, the annual exclusion gift to an ILIT is not available for that same beneficiary in the same year. This is a simple, but frequently overlooked, rule.


This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult your tax advisor or legal advisor regarding your specific circumstances.

Download our free guide to learn seven steps for uncovering value-added planning through your clients’ tax returns.

This post originally appeared on Commonwealth Independent Advisor, a blog authored by subject-matter experts at Commonwealth Financial Network®, the nation’s largest privately held independent broker/dealer–RIA.


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