For most people, the primary function of an estate plan is to provide for the distribution of estate assets after death. If you have a moderate to large estate, however, you likely need to start the transfer of wealth now to avoid a huge gift and estate tax bill when you die. One estate planning tool that can help with the transfer of wealth, but that is frequently over-looked, is the yearly gift exclusion.
To understand how valuable the yearly gift and estate tax exclusion can be you need to understand how estates are taxed. When you die, the value of all your estate assets, combined with the value of all taxable gifts you made during your lifetime, is potentially subject to gift and estate taxes. In other words, if you made gifts valued at $2 million while you were alive and then left behind an estate worth $5 million, your estate would be potentially owe taxes on $7 million. Each taxpayer, however, is entitled to exempt up to the lifetime exemption limit which is set at $5 million and adjusted annually for inflation. For 2014, the lifetime exemption limit is $5.34 million. Therefore, in the example given, your estate would be taxed on $1.66 million ($7 million – $5.34 million = $1.66 million). At a tax rate of 40 percent, your estate could lose $664,000 to gift and estate taxes.
If, however, you had taken advantage of the ability to use the annual gift and estate tax exclusion you could have reduced that tax bill even more. The annual exclusion lets you gift up to $14,000 each year to as many beneficiaries as you wish tax-free. Not only do you not pay taxes on the gift, but the value of the gift is also not used to calculate the lifetime exemption limit. If you are married you can even “gift-split”, meaning you can combine gifts to give gifts valued at $28,000 to as many beneficiaries as you wish.
To see how the annual exclusion can help, assume you have two adult children. Further assume that you have four grandchildren and you have a charity that is dear to you. Each year, you could give a gift of $14,000 to each of your children and grandchildren as well as to the charity, for a total of $98,000 per year gifted tax-free. If you did this for just ten years, your estate value would diminish by $980,000, leaving a taxable estate of $680,000. Your estate’s gift and estate tax bill would then be reduced from $664,000 to $272,000, a savings of $392,000.
Be sure to discuss how you can make use of the yearly exclusion in your estate plan with your estate planning attorney.
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