You can take a few simple steps to significantly reduce (or eliminate) your gift and estate tax. And at the same time you can protect your family – big time. The bad news is that if you ignore this subject, you’ll needlessly take money out of your heirs’ pockets and put it right into the hands of Uncle Sam. Worse, you could put money into your heirs’ pockets too soon and allow them to potentailly squander it all. Neither of these alternatives are too attractive. Here’s how to solve this problem.
Your Greatest Tool – Federal Gift Tax Exclusion
The Federal Gift Tax Exclusion allows you to transfer money to others without reporting it and without paying any tax on the transfer. In 2012, you can give gift anyone you like $13,000. Congress adjusts that amount up from time to time to keep up with inflation.
If you are married, you and your spouse can each gift that same person $13,000 annually. You can make these gifts to anyone you like and you can make those gifts to as many people as you like. They do not have to be related to you. Over a couple of years you can see that it’s pretty easy to transfer a lot of cabbage out of your taxable estate. Live long and prosper.
Gifting moves money out of your estate so it reduces your exposure to estate tax. And it also protects assets from creditors. Double payoff.
And if you need to reduce your estate faster, here are a few additional tools at your disposal:
- Charity – You can make charitable contributions without triggering a gift tax or the reporting requirement.
- Spouse – when you transfer assets to your spouse, it isn’t considered a gift.
- Payments made to political organizations aren’t considered gifts.
- Payments made for the benefit of another person for tuition or medical expenses as long as the payments are made directly to the respective institution are also not considered gifts.
The Problems With Direct Gifts
Many people I know don’t want to make gifts directly to relatives. They are afraid of what those individuals might do with the money. To solve this problem they use a trust.
Done right a trust can effect a tax-free gift yet still give your heirs some protection from themselves. You can do all this by tapping into the power of the Crummey trust or irrevocable life insursurance trust.
Here’s how this works.
Let’s say you love your daughter and want to provide for her but you don’t want to put a pile of cash into her hands just yet. You recognize that she’s a huge spendthrift.
You set up a Crummey trust and use it to buy an whole life insurance policy (this is one of the only times you’ll ever see me endorse whole life or universal life vs term life insurance.)
You gift the trust $13,000 every year and the trust uses that money to pay for the life insurance. When you die, your loving daughter will get the life insurance proceeds estate tax free. On top of that, you will have reduced your taxable estate by the cumulative premiums you took out of your estate and paid into the trust to make those insurance premiums.
The Tricky Part
In order for this to work you must send a written notice to your daughter that you’ve made a gift to the trust. The trust must be written in such a way that allows your daughter to withdraw that $13,000 within a window of time (usually 30 to 60 days).
Hopefully, your daughter understands how to play ball. She must understand that if she actually exercises her right and pulls that $13,000 out of the trust, she’ll get that $13,000 but that’s it. If she withdraws the premium, the insurance will lapse and she gets nada when you pass away.
You can take further steps to protect your family if there is a spending problem. You an appoint a trust trustee and direct her to only pay the beneficiaries the interest from the death benefits of the life insurance and keep the principal intact.
This strategy is very strong. It helps you take advantage of the Federal Gift Tax Exclusion. It harnesses the power of life insurance. And it keeps your heirs from spending all the loot even after you are gone if you so desire.