Lifetime Gifting: Transferring Wealth and Enhancing Your Legacy

Lifetime Gifting: Transferring Wealth and Enhancing Your Legacy

 

One of the best ways to enhance your legacy and minimize your exposure to transfer taxes is by implementing a gifting strategy combined with an Irrevocable Life Insurance Trust (ILIT). Gifting, combined with an ILIT, also allows you to meet other planning goals such as avoiding probate, increasing creditor protection, and giving you greater control and flexibility over how your assets will be distributed. A lifetime gifting strategy, in conjunction with life insurance, may also increase the total amount passed on to your heirs.

UNDERSTANDING U.S. TRANSFER TAXES

The U.S. federal government imposes a tax on the transfer of wealth above certain amounts. There are three distinct types of “transfer taxes” that may apply:

  • Estate tax – Tax on the transfer of property at death.
  • Gift tax – Tax on the transfer of property during life.
  • Generation-Skipping Transfer (GST) Tax – Tax on the transfer of property (during life or at death) to individuals who are more than one generation removed from the donor, commonly referred to as “skip persons” (e.g., a grandchild)

In addition to federal taxes, several states impose a state-level estate tax or inheritance tax, depending on where you live or own property.

WHEN TRANSFER TAXES ARE DUE

  • Lifetime exemption – You can give away a certain amount of money or property during life or at death without incurring any gift or estate tax. This amount is called the “lifetime exemption” and in 2021 is $11.7 million for individuals and $23.4 million for married couples. Transfers made in excess of this exemption are taxed at a 40% rate.
  • GST tax exemption – The GST exemption, which applies to grandchildren and other “skip persons,” is also $11.7 million per individual. Transfers that exceed this exemption are taxable at a 40% rate.
  • Annual exclusion gifts – In addition to your lifetime exemption, you can also give up to $15,000 per year to as many individuals as you would like. Spouses can combine their annual exclusion amounts to give a total of $30,000 per individual per year. The total amount you can give on an annual basis without tapping into your lifetime exemption may be significant. For example, if you have six identified trust beneficiaries, you can give $90,000 ($15,000 x 6 individuals).

However, the clock is ticking. Under current law, the Lifetime and GST Exemptions will be reduced to $5 million (indexed for inflation) in 2026.(1)

One can only speculate about what the federal exemption will be at your eventual passing, or what tax revenue structure the individual states may continue to concoct on their own.

MAXIMIZING YOUR LEGACY WITH LIFE INSURANCE

Implementing a gifting plan to fully utilize your available exemptions can help to significantly minimize or eliminate your exposure to estate taxes. One very efficient strategy is to make gifts to an ILIT using annual exclusion gifts and/or some of your lifetime exemption and have the ILIT trustee use the gifted funds to purchase life insurance. The steps are as follows:

  1. Your attorney drafts an ILIT.
  2. You fund the ILIT with annual exclusion gifts of $15,000 for each beneficiary of the trust. You may use your lifetime exemption to gift larger amounts to the trust.
  3. The ILIT trustee purchases an insurance policy on your life. The ILIT is the policy owner and beneficiary, with premiums paid from the gifted funds.
  4. At your death, the ILIT receives the death benefit free from income and  estate taxes. By funding the ILIT with life insurance, you not only remove the gifted assets from your estate, but the policy’s death benefit creates and income tax-free pool of money, potentially increasing the overall benefit you pass on.

HOW LIFE INSURANCE CAN HELP

  • Income tax-free death benefit. Death benefit is received income tax-free and can be used to help pay estate taxes (if any) and secure a legacy for your beneficiaries.(2)
  • Access to tax-free income. Cash value that accumulates inside a permanent life insurance policy can be accessed tax-free and distributed to beneficiaries.(3)
  • Competitive Rate of Return. Life insurance death benefit generally provides a higher rate of return compared to other investment options through life expectancy.(4)

BENEFITS OF TRUST PLANNING

Gifts may be made directly to beneficiaries or to a trust. When gifted to an ILIT, the assets will be excluded from estate tax and the trust structure provides additional benefits(5), including:

  1. Enhanced inheritance protection.
    • Greater control over timing of distributions (e.g., at ages 35/40/45, discretionary income/principal only).
    • Increased flexibility over distribution (e.g., may be limited to income or for a specific period).
    • Ability to preserve funds for multiple generations.
  2. Flexibility and access.
    • Spousal lifetime access provisions can provide your spouse with access to funds inside the trust ILIT.
    • A multi-generational trust allows trust assets to pass to grandchildren and future generations without paying GST taxes.
  3. Easy funding.
    • Can use annual exclusion gifts ($15,000 per beneficiary).
    • Increased lifetime exemptions ($11.7 million in 2021) makes it easy to fund larger premiums gifts without incurring tax.
  4. Increased creditor protection.
    • Protection of trust assets from future creditors who may try to go after you or your estate.
    • Protection from beneficiaries’ creditors, such as ex-spouses, third party creditors or bankruptcy.
    • Spendthrift language can protect a beneficiary from reckless spending and preserve trust assets.

 

Footnotes:
(1) IRS has clarified that there will be no “claw back” of exemption used before 2026.
(2) Life insurance death benefit proceeds are excludable from the beneficiary’s gross income for income tax purposes, with a few exceptions including
transfer for value.
(3) Loans and withdrawals will reduce the death benefit and cash surrender value and may cause the policy to lapse, which may cause recognition of taxable
income. Policies classified as MECs may be subject to tax hen a loan or withdrawal is made plus a 10% federal tax penalty if taken prior to age 59½.
(4) IRR on death benefit is equivalent to an interest rate at which an amount equal to the illustrated premiums could have been invested outside the policy
to arrive at the net death benefit of the policy.
(5) GHJ is not a law firm and does not provide tax or legal advice. Please consult your tax and legal professionals.