Overview

Gifting programs can be extremely beneficial in reducing estate taxes. By gifting assets to heirs while living, people with larger estates can reduce their gross estate, which will in turn reduce estate taxes. If the value of assets gifted to heirs should grow, this future growth will also be removed from the estate and will further reduce taxes. Gifting is frequently used to acquire the life insurance which pays estate taxes. It is important to be careful when considering a gifting program. Even wealthy people should make sure that they leave sufficient assets to continue the lifestyle they enjoy.

Usually when life insurance is used to pay, or help pay, estate taxes, a gifting program is utilized. The most common gifting program would be the use of the annual gift exclusion. Each individual is allowed to gift up to $10,000 per person annually.. That means that a husband and wife together could gift up to $20,000 per person per year. These gifts may consist of cash, real property, securities, business ownership, etc. Often, when Estate taxes are anticipated, cash is gifted to purchase life insurance in which a child or ILIT is the beneficiary.

The Unified Credit allows anyone to give up to $600,000 to someone else (usually a child or grandchild) during their lifetime, or at death. Larger estates often use all or part of the unified credit prior to death. The unified credit does not all have to be used at one time. For example, if you gave someone $100,000 while you were alive, your $600,000 would be reduced to $500,000. This means that at your subsequent death, only the first $500,000 would pass to heirs without estate taxes. Since any person can pass up to $600,000, a husband and a wife together can pass $1.2 million dollars to heirs (in a well planned estate) without estate taxes.

In some estates (mostly large ones), the entire unified credit is used while both spouses are alive. A husband and wife together might give $1.2 million to their heirs while they are alive. Often this amount is considerably leveraged up by using life insurance to pay a large future estate tax bill. Keep in mind that annual gifting can be used alongside the present or future use of your unified credit. Always consult a CPA before beginning a gifting program.

Leveraging Your Gifting Program

Many people arrange for life insurance to be purchased with money that is gifted to their heirs in order to leverage their gift. An annual gift of $10,000 converted to life insurance might purchase over a million dollars worth of second to die life insurance for a husband and wife 60 years of age. Many wealthy clients will take their $1.2 million and "invest" the entire amount in a life insurance program that is in an ILIT. Depending on the age and health of the insured's, they might be able to buy a death benefit over 10 times greater than the premium "invested." This would be an excellent example of the substantial leverage that can be achieved through life insurance.

Grandchildren

Since life insurance can be used to leverage the amount "invested" into a much higher sum, life insurance is often used in trusts for the benefit of grandchildren. The cash values grow tax deferred. However, the gain inside the contract is never recognized if the life insurance is kept until death, due to the income tax free nature of the death benefit. If properly set up, the grandchildren can receive the insurance proceeds free of estate taxes. Moreover, life insurance is the vehicle of choice to get money exceeding Generation Skipping Limits to grandchildren without incurring additional taxes. Annual gifts to grandchildren or partial use of the unified credit can be leveraged with life insurance. This can allow a wealthy family to leave far more to grandchildren than would be possible under costly generation skipping taxes (in addition to estate taxes).

Generation Skipping

In large estates, many wealthy grandparents leave everything to their children, and the children pay the estate taxes. Later, when these children die, estate taxes again have to be paid before assets can be given to their children. Having to pay estate taxes twice on assets can put a huge bite on the assets that are left to grandchildren. It is often much more efficient to give assets straight to the grandchildren. Assets that are given this way are only subject to estate taxes once. This strategy is often used when the estate is sufficiently large to provide adequately for the children, as well as the grandchildren.

Keep in mind that there is a $1 million dollar limit for generation skipping from each spouse. This means that a husband and wife together could give a total of $2 million dollars to grandchildren (each grandchild could get a fraction of this figure). If you exceed generation skipping limits, you are subject to a substantial generation skipping tax. Many estate planning experts find the best way to significantly increase the generation skipping limits is by leveraging up the amount of the gift with life insurance. Annual gifts given to grandchildren would also increase, over time, the amount that could be "skipped."