Why The Wealthy Write These Checks At Year End


There is a ritual that often occurs in high net worth households in the final weeks of the year. It can be a check in the mail or tucked inside a Christmas present. At other times, it may be a deposit into a 529 plan or a trust without the beneficiary knowing. Regardless, we are at the time of year when the older generations in wealthy families make the annual gift exclusion to the younger generations. The amount they typically gift them: $15,000 per person.

While this ritual is typical for those with means, it’s all part of a bigger strategy. For people able to make the annual gift, it’s about moving assets out of their estate. The annual gift exclusion is a simple and easy way to do it, because the IRS allows a taxpayer to gift a designated annual amount to anyone without incurring any gift tax. For 2019 and 2020, the maximum gift amount is $15,000 per donee. This means a married couple could gift to each of their family members $30,000 annually.

For the majority of Americans, the annual gift is irrelevant as they don’t have taxable estates and don’t make gifts of this magnitude. But for the high net worth, it can be a very powerful tool.

Estate Tax Is No Longer A Big Issue

Annual gifting has long been an estate planning technique of the wealthy. In the early 2000s, it was important to do annual gifting as the amount one could pass free of estate tax was low. For example, in 2001, the federal estate exemption was $675,000 and the estate tax rate was 55%. Getting assets outside of your estate was integral to avoiding a big tax hit.  While the estate tax exemption increased steadily to $3,500,000 in 2009 and a 45% tax rate through the aughts, the wealthy continued to be wary of having assets subject to estate tax at their deaths.

Since 2011, the amount that an individual can pass on free of estate tax has been steadily increasing, culminating in the recent change due to the Tax Cuts and Jobs Act of 2017 (TCJA). Now, for an estate to be taxable in 2020, it would require that an unmarried individual have assets in excess of $11,580,000 (for married couples, this would be an estate in excess of $23,160,000). Further the estate tax rate is the astonishingly low 40%.

Estate tax liabilities are now so low that the Tax Policy Center found that in 2001, there were 50,500 taxable estate tax returns filed compared to 2018 with only 1,900 taxable estate tax returns.

Yet the wealthy continue to use the annual gift exclusion as a planning tool – even though most of these individuals will likely not have an estate tax bill.

Potential Law Changes

Part of the reason wealthy families are still writing these checks has to do with the current structure of the TCJA. The higher exemption amount is set to sunset at the end of 2025 and the law will revert back to the $5 million estate tax exemption that it was prior to the TCJA plus inflation. Further, some of the presidential candidates have made it clear that they want to target wealthy households and that might mean a lower exemption even before 2026.

Further, a number of estate planning techniques require the use of the annual exclusion gift. For instance, many families use an Irrevocable Life Insurance Trust (ILIT) that owns insurance coverage on an individual or a couple. By owning it in an irrevocable trust, it is not included in the estate at death. But the annual exclusion gifts for the beneficiaries may be used by the trustee to pay for the life insurance premiums.

Cash is King

Further, it is not uncommon to find that some family members are dependent upon the gifts. While we often think of wealthy families as multi-generational, it is not uncommon for one generation – usually the older one – to hold the assets. The ability to gift allows a family to get support. That support could range from helping with regular expenses to strategic gifts that are leveraged to help with estate planning.

For instance, grandparents might want to help with their grandchild’s 529 plan. As a result, they might decide to make an annual exclusion gift to the 529 plan to help with this financial goal.  The money gets out of the grandparents’ estate, grows tax deferred and in the event the fund is used for qualified education expenses, it comes out tax free.

Additional Planning Ideas

Finally, there are some unique estate and income tax planning ideas that you can use with annual gifting. For instance, there is what is known as upstream gifting. In the event that the younger generation has low basis stock, they may want to consider gifting the shares to the grandparent who might be close to death. In those instances, the grandchild could inherit the shares back from the grandparent with no estate tax due to the higher exemption and get a step up in basis to the income tax date of death value. 

Good to Be On The Receiving End

Ultimately if you are in a family that does annual gifting, rest assured it’s all about estate planning. But it is key for the younger generations who benefit today to consider this strategy for their children and grandchildren as time goes on. Further, it reminds us that estate planning is a never ending process. The things we do today can help us save in the future.

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