Want to win the estate tax game? Think gifts. Leveraged gifts.
Lifetime gifts to your family represent a major tax-planning strategy. Gifts are an easy way to move assets within the family unit, remove future income from your estate, and provide for future generations. In the discussion that follows, all gifts are made by Joe, who is married to Mary, to his children or grandchildren.
Gifts divide family income by taking advantage of the zero- or low-tax bracket of one or more family members. This gifting strategy accomplishes two sure tax savings: 1) income tax—transfers income (produced by the asset gifted) from Joe’s high bracket to the low bracket of his children and/or grandchildren, and 2) estate tax—the asset is removed from Joe’s estate.
Current law still provides these advantages: 1) the $24,000 ($12,000 for Joe and $12,000 for Mary) annual exclusion per donee, and 2) gift splitting with Mary removes one-half of the gift from Joe’s estate and Mary’s estate as well.
I’m about to use boxcar-dollar numbers to show you the power of leveraged gifts. Adjust the numbers (raise or lower the amount of the gift) to your liking. If you have children or grandchildren, you’ll like what you are about to read.
Here’s an example of a classic leveraged gift. Joe and Mary (both 60 years old) would like to enrich their six grandchildren. Instead of making $24,000 gifts each year to each grandchild, here is what they do. Joe and Mary create a wealth creation trust (an irrevocable life insurance trust that receives insurance death benefits free of the income tax and estate tax). They find out that they can purchase a $1 million second-to-die policy (pays after the second death of Joe and Mary) for a premium cost of only $12,709 per year, with premiums stopping after 15 years.
So, Joe and Mary make a gift of $12,709 each year to each of their six (total gifts each year of $76,254; $12,709 X 6) grandchildren via a wealth creation trust to pay an annual premium for six separate $1 million second-to-die policies for a 15-year period (then the policies will self-carry). After Joe and Mary are gone, the grandchildren will have $6 million ($1 million each) tax-free at a maximum lifetime cost of only $1,143,810 ($76,254 × 15).
And there’s more. Assume Joe is in a 50% estate tax bracket. So remember, every time Joe pays the $76,254 in premiums, that $76,254 is out of Joe’s estate. The results: exactly one-half of each premium dollar is, in effect, paid by the IRS. Simply put, Joe gets a 50 percent discount on his insurance.
The power of using insurance to make leveraged gifts: How much do you think Joe must earn to leave his grandchildren or children $6 million? Would you believe about $20 million? Try this: Joe earns $20 million before going to heaven. After giving the IRS (and Joe’s home state) 40% for income taxes ($8 million) he has $12 million left. When Joe and Mary go to heaven, the IRS gets 50% of the $12 million for estate tax. What’s left? $6 million.
Or put another way: an investment of only $1,143,810 over 15 years (a realistic goal for Joe) will do the same work as Joe earning $20 million (an impossible dream).
Shhh! Don’t tell the IRS. What most people don’t know is that life insurance, when properly purchased, is the most tax-advantaged investment available under the entire tax law. If you have funds invested in a qualified plan (for example, an IRA, 401(k), profit-sharing plan or the like), or in traditional investments (CDs, stocks, bonds or the like), and if you (and/or your spouse) are insurable, it’s easy to turn thousands of dollars into millions of dollars.