Do you ever wonder why some high net worth individuals give substantial amounts away to loved ones during their lifetime? Yes, it’s emotionally rewarding to watch others benefit from one’s wealth. But it can also be financially rewarding, as it saves beneficiaries from paying a bundle in gift taxes down the road.
Following are a few easy strategies that can help reduce or avoid estate taxes and are also effective wealth transfer vehicles:
1. Gifting Cash
The most straightforward strategy is gifting your loved ones the amount of the annual gift tax exclusion. It’s $14,000 for 2015, the same as 2014, and up from $13,000 in 2013.
Under the gift tax exclusion, you can give away $14,000 to as many individuals as you’d like within a year without filing any paperwork or incurring gift tax liability. Married couples can double their gifts, giving as much as $28,000 each year per recipient. So a husband and wife could make $14,000 gifts to each of their four grandchildren, for a total of $112,000.
The good news about this strategy is that as long you don’t gift over $14,000 in a year, it won’t count toward your lifetime gift exemption ($5.43 million in 2015, up from $5.34 million for 2014)
2. Paying College Tuition or Medical Bills Directly
Tuitions and medical bills are two exceptions to the annual gifting limit. If you pay medical expenses or college tuition directly to the institutions providing the services, the $14,000 limit does not apply.
Better yet, even after covering the cost of college tuition or private school expenses on behalf of your child or grandchild, you are still entitled to give that child additional tax-free annual gifts up to the $14,000 exclusion amount.
The same is true you pay for braces for a child’s teeth, or cover the costs of a surgery by sending that amount directly to the medical facility.
3. Front Loading a 529 College Savings Plan
In this gifting strategy, you’re helping a child or grandchild save for college by contributing up to five years’ worth of the annual exclusion in one year ($70,000 in 2015, or $140,000 for a married couple giving a joint gift).
This strategy allows your money to grow in a tax-exempt environment.
But remember, once you take advantage of this five-year plan, you cannot give additional annual gifts to the same child within that period without it subtracting from your lifetime gift tax exemption.
Also, if you die within five years of the date of your gift, a prorated portion of the original gift will be included in your estate tax calculation (any growth will not be included).
4. Gifting Appreciated Assets to Lower Income Tax Brackets
Taxpayers in the lowest two brackets (10% and 15%) currently benefit from a 0% rate on long-term capital gains and qualified dividends. Therefore, another good gifting strategy is to transfer appreciated stocks or mutual funds to beneficiaries instead of cash.
If the recipient is in one of the lowest tax brackets, the asset could be subsequently sold without any capital gains tax (before the end of 2015).
5. Set up a Trust
Trusts are designed to help you transfer your wealth efficiently while avoiding probate and reducing estate taxes. With this strategy, you pay the annual taxes on the trust income while having the potential to help multiple generations of beneficiaries and reducing taxes on your estate.
There are several different kinds of trusts you can form according to your individual needs, including life insurance trusts, irrevocable gift trusts and revocable living trusts.
Trusts are a key component of an estate plan and often end up being substantially more valuable to the recipient than assets received by the beneficiaries outright.
For example, if a healthy 64 year old female were to establish an irrevocable life insurance trust and simply gift $14,000 to it for the annual premiums, they would be pleasantly surprised. This would result in a trust immediately valued at approximately $1,100,000, completely estate tax free.