Gifting is one of the most powerful and versatile tools in a high net worth individual’s estate and wealth planning repertoire.
It can speak to love and concern for family members, the desire to create a legacy that will preserve and amplify hard-earned wealth for descendants, the intention to support a charity or cause, finance estate taxes or shift wealth from estate tax exposure. The impact of a gift can be made even more powerful by understanding gifting strategies and best practices that maximize the value of the gift—strategies that are best executed with the help of seasoned financial and estate planning professionals.
The best way to get started is to have a clear understanding of:
The purpose of the gift
The highest and best use of the gift
An understanding of trusts
There are two kinds of gifts: annual gifts and lifetime gifts. The annual gift limit is $16,000 per recipient, per donee. An annual gift reduces the taxable estate and is replenished each year, and periodically increases with the cost of living. For example, a married couple with two children can give away $64,000 per year to their children. In 2022, the lifetime exemption against gift tax, estate and generation skipping transfer tax (GSTT) is $12.06 million per spouse and $24.12 million per married couple. Because this transfer can be used either during life or at death, it does not reduce the taxable estate. However, it is still a very powerful planning tool. It is important to note this large lifetime gift exemption sunsets at the end of 2025, when it will revert to $5 million (expected to be approximately $6.2 million when adjusted for inflation) barring legislative action.
What is the purpose of the gift?
Maximizing the power of a gift is not necessarily measured by how much wealth is transferred, but rather, the gift’s impact on the intended purpose. Gifts can generally be divided into two types: Immediate needs and wealth appreciation shifting.
Immediate needs are best funded in cash and include living expenses, medical expenses, education, special needs, down payments for a house, and life insurance to protect the future of the beneficiaries. Life insurance is well-suited to provide:
Equalizing a blended family
Equalizing a business legacy for a child not in the family business
Prenuptial planning for a child that may inherit substantial assets
Liquidity to finance the estate tax for a valuable non liquid asset where insurance is best held in an irrevocable trust.
Wealth appreciation shifting in a trust uses lifetime gifts that will shift the appreciation of transferred property from the grantor’s estate to a trust estate benefiting the grantor’s descendants.
A trust is a fiduciary arrangement that allows a third party (the trustee) to hold assets on behalf of trust beneficiaries. It is empty until filled, usually with gifts. In the estate planning context, the trust is irrevocable, meaning it can’t be changed and trust assets are excluded from the trust grantor's taxable estate. More often than not, the irrevocable trust is a grantor trust, meaning that the grantor is responsible for the income taxes on trust assets until death, when the trust becomes a non-grantor trust and is responsible for its own taxes. Trusts can hold any asset class including business interests, real estate, registered and non-registered securities, and life insurance.
Irrevocable trusts can include:
Irrevocable Life Insurance Trusts (ILITs)
Spousal Lifetime Access Trusts (SLATs)
Intentionally Defective Grantor Trusts (IDGTs)
Maximizing the power of gifting
Wealth appreciation shifting
Short of giving away one’s wealth to charity, estate tax cannot be avoided. What is possible, however, is to shift an asset’s appreciation to minimize the grantor’s estate and GSTT exposure and maximize the future value of a gift through annual and lifetime gifts to a trust.
What assets will maximize the power of gifting?
An asset with high appreciation potential
An asset with high discount potential
An asset with both
Some examples of assets with high appreciation potential include:
Stock options (if permitted)
Closely held business interests
Pre-IPO/merger/private equity business interests)
Alternative assets (hedge funds)
Investment real estate
Private equity investments
Assets with high discount potential are any assets that have a lack of control or lack of marketability. For example:
Minority interests in closely held business interests
Limited partnership interests
Minority interests in real estate investments
Private equity investments
The best type of asset to transfer can be discounted today with high appreciation potential in the future. If both conditions exist, discounts can be between 20% and 36%. If the asset is ultimately sold for fair market value, the trust holding the asset will realize the wealth appreciation.
Other considerations include the type of trust used, and for a grantor trust, the income tax ramifications attributed to the grantor on assets given away.
For a high net worth family making new investments in either a business or real estate, giving away an interest in a new venture with a low discounted value today and high appreciation potential can be very powerful.
Case in point A high net worth real estate developer embarked on the rehabilitation of an old hotel. He invested $5 million in the project and gave away 49% of the interest to a dynasty trust. When the project is finished in five years, he anticipates that the value of the property will exceed $40 million. His $2.5 million gift today will ultimately shift $37.5 million in trust for the benefit of his family, reduce his future estate tax liability, and provide cash flow for children and grandchildren in the future.
Trusts to meet gifting needs
Spousal lifetime access trusts (SLATs)
Grantors making a large lifetime gift can balk at the loss of access and use of the gifted assets. A SLAT can address this issue by providing lifetime income for the trust beneficiaries, including the grantor’s spouse. If needed, the trustee can distribute trust assets to the grantor’s spouse for any purpose including the grantor’s support. When the grantor dies, the trust’s assets are not included in the grantor’s taxable estate and are available for use by the beneficiaries. There are two problems with SLATs. First, if both spouses create SLATs, beware of the reciprocal trust doctrine, which can void the SLATs if the trust documents are not different. Second, if the grantor’s spouse dies before the grantor, the grantor will lose access to the funds in the SLAT. This problem is easily solved by insuring the spouse with sufficient life insurance to replace the assets in the SLAT for the benefit of the grantor. Insuring the grantor’s spouse maximizes the power of the SLAT for the benefit of the grantor, the spouse, and other trust beneficiaries.
Intentionally defective grantor trusts (IDGTs)
These trusts are typically used with a combination of a discounted gift of property with cash flow and loans. The combination of discounted gifts and loans can supercharge the value of a lifetime gift.
Case in point A real estate entrepreneur had no annual gifting capacity and limited lifetime gifting capacity. On the advice of counsel, he transferred a 49% interest in a real estate project with an 8% cash flow worth $10 million to a trust for a combination of a gift and a note. The value of the property after discounts was $7 million. The value of the gift was $700,000 and the value of the note was $6.3 million at 2.5% interest. After the transaction was complete, the trust received annual income of $800,000, and owed $157,500 on the note leaving $642,500 of cash flow to the trust. The trust used $406,500 to purchase $30 million of survivor life insurance on the grantor and his spouse. The excess annual cash flow was used to reduce loan principal. A $700,000 gift was maximized by the transfer of a $10 million property, appreciation on the property, and $30 million of trust-owned life insurance.
Dynasty trusts are the ultimate tool to maximize gifting. This is because assets gifted to a dynasty trust are exempt from both estate tax and GSTT. However, a dynasty trust is not exempt from income tax. If the dynasty trust is a grantor trust, the grantor is responsible for the income tax of trust assets. If the dynasty trust is a non-grantor trust, the trust itself is responsible for income tax and the maximum tax rate is levied on any income in excess of $13,451 in 2022.
Life insurance's unique income tax treatment can enhance the power of gifting to a dynasty trust as follows:
Premiums payments—After-tax dollars are used.
Tax-deferred growth—Accumulated investment income credited to a life insurance contract is not subject to current taxation .
Income tax-free distributions from non-modified endowment contracts—Withdrawals up to the policy owner’s basis are income tax-free  and policy loans provide income tax-free access to accumulated investment income .
Income tax-free death benefit proceeds—Death benefits received from a life insurance contract, including any accumulated investment income, are generally received income tax-free .
Estate and GSTT tax-free proceeds—Trust-owned life insurance death benefits owned by, and payable to, a trust may be excluded from the insured’s taxable estate and exempt from GSTT.
Tax-free reallocations—Policy account values may be transferred among the investment options available within the policy without creating taxable events.
Further, one of the objections to large gifts is the loss of step-up in basis available to assets included in the taxable estate. The income tax-free gain of the death benefit over the cash value and the cumulative premiums is almost the same as the step-up in basis on assets included in the taxable estate. A well-designed life insurance program held by a dynasty trust can further maximize gifting through income, gift, estate and GSTT optimization.
Case in point
A CEO and his wife, both in their 70s, had done estate planning and, through grantor retained annuity trusts, loans, testamentary dispositions and lifetime gifts, intended to leave each of their five children $25 million. However, they wanted to provide for their 10 grandchildren as well. So they carved out $4 million of their lifetime exemption, placed it in a dynasty trust, and purchased life insurance, not on themselves as grantors of the trust, but on their children with the grandchildren named as equal share beneficiaries of the trust. A total of $4 million of premium purchased an aggregate of $44 million of life insurance. With the life expectancy of the children, if they hit their investment targets, the value of the life insurance could ultimately be approximately $90 million. Policy cash values will likely grow and be available to provide liquidity during the insureds’ lives. This is a prime example of maximizing a gift.
Intelligent gifting will help maximize opportunities
Whatever the reason for a gift, intelligent gifting strategies will help maximize gift-giving opportunities, and should include three key steps:
Take stock: Assess which assets are best suited to be maximized, who will benefit from the gift, and why.
Consider life insurance: Life insurance is an incredibly flexible tool that can further diversify trust assets, minimize trust portfolio income tax exposure, address a loss of step up in basis for the grantor, and provide a ready source of cash.
Partner well: Gift maximization requires professionals who think creatively about how to ensure efficient asset transitions and have a deep understanding of multiple disciplines.
This material and the opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual or entity. To determine what is appropriate for you, please contact our firm. Information obtained from third-party sources are believed to be reliable but are not guaranteed.
The tax and legal references attached herein are designed to provide accurate and authoritative information with regard to the subject matter covered and are provided with the understanding that neither M Financial Group, nor TRC Financial, are engaged in rendering tax, legal, or actuarial services. If tax, legal, or actuarial advice is required, you should consult your accountant, attorney, or actuary. Neither M Financial Group, nor TRC Financial, should replace those advisors.
All examples are hypothetical and for illustrative purposes only and may not reflect the typical clients experience; they are not intended to represent or guarantee that anyone will achieve the same or similar results.
An insurance contract's financial guarantees are subject to the claims-paying ability of the issuing insurance company.
Cash value accumulation is determined by the policy contract, is not always guaranteed, and is subject to withdrawals. Cash values and death benefits may vary based on the policy you purchased. Please consult your full policy illustration at the time of purchase.
Loans and partial withdrawals will decrease the death benefit and cash value and may be subject to policy limitations and income tax.