For growing numbers of individuals and
families, sharing the wealth now while they can see the smiles it generates
is gaining in popularity.
But when it comes to giving away our assets to loved ones, the matter can
quickly become complex. In fact, two serious pitfalls can derail your
generosity and cost you and your loved ones dearly. First, when you give
away your wealth, you also give up control, and in some circumstances, that
can be a blueprint for disaster.
Secondly, unless you exercise great care in your giving, you may
inadvertently create a taxable event for yourself or your loved ones. Let’s
look at both these gifting pitfalls and see how you can avoid them.
GIVING
AWAY YOUR MONEY WITHOUT LOSING CONTROL
It may sound uncharitable to suggest that
you keep control over your assets, even as you give them away to loved ones.
But sometimes doing just that is the best way to ensure that your loved ones
truly benefit from your legacy. Here’s why.
The minute your gift leaves your estate and becomes part of a loved one’s,
it is subject to a host of threats. It can be lost to creditors if the loved
one has bad debts or liens, for example. Or if your legacy is co-mingled
with a loved one’s spouse, some or all of it may be lost in a future divorce
action. Of equal concern is the fact that not everyone has the wisdom,
maturity or financial savvy to make the most of your gift. Even loved ones
with the best of intentions may squander your legacy through errors in
judgment or other costly mistakes. Fortunately, you can give away your
wealth while still retaining control with a number of strategies.
MINOR’ S
TRUSTS
Similar to this custodial account in many
ways is the Minor’s Trust (also known as a 2503(c) trust), with a few
significant differences. First, the Minor’s Trust requires annual trust tax
returns. On the plus side, however, the first $5,000 in income earned by the
trust is taxed at only 15 percent, with income over that amount taxed at 28
percent, so it is ideal for large gifts. Finally, the Minor’s Trust allows
you, as Trustee, a much greater degree of control while the child is a
minor. Then, after the child reaches the age of majority, he or she has just
30 to 60 days to withdraw the funds from the trust. Failing to do so will
allow you to retain control of trust funds until the date you’ve specified.
IRREVOCABLE LIFE INSURANCE TRUST
A surprising fact to many is that the life
insurance you own can actually increase your estate tax bill. Here’s a
solution that let’s you avoid estate taxes on your life insurance policy
while seeing to it that your loved ones benefit fully from the policy’s
proceeds. The Irrevocable Life Insurance Trust (ILIT for short) owns a
policy on your life and names your loved ones as beneficiaries. Any policy
premiums under $11,000 that you may pay are tax-free, as long as you follow
the tax guidelines for ILITs.
As part of the ILIT’s design, you create instructions as to when, how and
why your loved ones may use the policy’s proceeds after you’re gone, and you
designate who you want to manage the funds on your loved ones’ behalf. For
instance, you can have a professional money manager oversee funds on behalf
of a beneficiary who is still a child or who may have little financial
experience.
You can designate how much money should be paid out and how often. You can
even determine under what circumstances loved ones should receive
disbursements:
For example, money for college, a down
payment on a new home, etc. With the ILIT, you can ensure that your loved
ones -- and no unintended creditors, ex-spouses or others -- put this
money to best use.
In addition, you may even be able to
provide loved ones with a source of emergency funds before you pass away.
Some policies have generous no-cost or very low-cost policy loan
provisions. You can include directions in your ILIT’s trust documents
about those circumstances in which you’ll permit loved ones to make policy
loans while you live.
THE
FAMILY LIMITED PARTNERSHIP
Finally, in some circumstances, a Family
Limited Partnership (FLP) may be the best bet for removing assets from your
estate and into the estates of your loved ones, all while retaining complete
control over the asset.
Ideally suited to a family business but also used for many other types of
assets, the FLP lets you transfer ownership to a special kind of limited
partnership. You and your loved ones own “interests” in the partnership,
rather than owning the assets themselves. By naming yourself the general
partner of your limited partnership, you retain complete control over how
the asset is managed, even earning income for your management duties.
One of the biggest advantages to the FLP is the socalled valuation
adjustment, which means that the ownership interests are valued lower for
tax purposes than the actual value of the underlying asset. As a result, you
can give away more of your wealth to loved ones, and you can do so much
faster, than you could otherwise. Further, ownership of an asset that can’t
be readily split into pieces -- such as real estate or a family farm or
business -- can be easily distributed fairly and equally among loved ones,
while keeping the asset intact.
GIVING
WITH NO STRINGS ATTACHED
Your loved ones may be mature, financially
experienced and immune from the threats of creditors, lawsuits or divorce.
In that case, you may want to give away your wealth to them now, while you
can live to see them enjoy the fruits of your hard work.
You can give away assets to your loved ones tax-free if you follow a few
simple guidelines. Each year you can give away up $11,000 per recipient
gift-tax and estate tax free. You can give away $11,000 to as many
individuals as you like, and still do so without a tax penalty. If you’re
married, you and your spouse can give a combined gift of up to $22,000 to an
individual, and still avoid the tax man’s reach.
What if you want to give away more than $11,000 per person? You can do so
without a tax penalty, if you apply the difference to your lifetime estate
tax exemption. The estate tax exemption for 2004 is $1.5 million per person.
A married couple can give away a combined $3 million. There’s no reason you
can’t give away more than your exemption. But just remember that you’ll
expose anything over that amount to gift or estate taxes. These taxes can
add a costly penalty to your largess.
TAXING
YOUR LOVED ONES
Even if you follow the guidelines and keep
your gifts within your exemption amounts, you may still create a tax
liability for your loved ones. For instance, if you give away a highly
appreciated asset -- such as a stock portfolio, real estate or work of fine
art - - you may also be passing on a large capital gains tax bill, should
they ever sell your gift.
Gifts made while you live retain your original “cost basis,” your investment
in the asset. When loved ones sell the asset, they will have to pay capital
gains taxes on the difference between the asset’s selling price and your
original purchase price. That can add quite an unexpected sting to your act
of generosity.
On the other hand, assets passed on to loved ones at your death receive a
“step-up in basis,” meaning that their current market value becomes your
loved ones’ cost basis, allowing them to save on capital gains taxes. For
that reason, you’re better off giving cash or assets which have not
appreciated significantly to loved ones while you live, and waiting until
after death or using strategies like the Charitable Remainder Trust to
dispose of highly appreciated assets.
WHEN TO
GIVE WITH CAUTION
As much as I hate to curb any generous
impulses you may have, there are occasions when you should give carefully,
or perhaps not at all. I urge you to proceed with caution and seek the
advice of a professional if you encounter any of these warning signs:
YOU MAY
NEED MEDICAID BENEFITS IN THE FUTURE
To discourage Medicaid abuse and fraud, the
government has enacted harsh penalties for those who apply for Medicaid
assistance if they know they are ineligible. And it’s easier than you might
think to be ineligible for Medicaid benefits. The government enforces a
“look back” period of three to five years on Medicaid applicants. If the
government finds that during the “look back” period, you gave away assets
that might now be used to pay your medical expenses, it may declare you
knowingly ineligible. The alternative, if you have given away assets to
loved ones and your health or finances take a serious turn for the worse, is
to wait for up to three to five years before you can legally apply for
benefits. So, if you think you or your spouse may need the government
support of Medicaid, be very careful about when, why and how you give your
assets away.
YOU PLAN
TO USE JOINT TENANCY TO GIVE AN ASSET AWAY
Many consumers own assets with loved ones
as joint tenants with rights of survivorship. Joint tenancy means that all
the joint tenants own 100 percent of the asset. If one of the joint tenants
die, the others immediately inherit his or her ownership interests, avoiding
death probate. But it has significant drawbacks. If the joint tenants are
married and have a taxable estate, they will lose one of their two estate
tax exemptions -- a mistake that will cost heirs over $200,000.
If you should add someone other than your spouse to an asset, you may incur
costly gift or estate taxes. Finally, whether joint tenants are married or
single, they expose the entire asset to risk if one of the joint tenants is
sued, has bad debts or unpaid taxes. If you’re looking for ways to give your
wealth away to your loved ones while you live, there are much better options
than joint tenancy.
Before you make a significant financial gift to loved ones, be sure to
review your plans with us. We can help you ensure that your generosity does
what you intend it to -- without creating a costly taxable event for you or
your loved ones. |
