Important note: All exemption amounts mentioned in this article apply to U.S. citizens only and were current as of April 1, 2024.
There is a lot to consider when passing your assets on to the next generation. How will your decisions affect the lives of those who receive your gifts? How will your choices impact your family as a whole? How will your family’s assets be handled after you pass? Lastly, how can you transfer your wealth in a way that loses as little as possible to taxes?
It is best to take a systematic approach to passing along assets while limiting your tax liability. Start with the core elements of estate planning and progress to more complex tools as necessary. The outline below can help guide you through the levels of creating an estate plan designed to avoid unnecessary tax consequences.
1. Establish the Basics of Your Estate Plan
Step one is to ensure that you have the basics covered in an up-to-date estate plan. This includes a will, revocable trust, powers of attorney and beneficiary designations for your retirement accounts and life insurance.
When done properly, the estate planning process takes into account estate tax liability and generation-skipping transfer (GST) taxes at the time of your passing. It also considers the tax implications of the methods used to pass along your assets.
For people who are married, an estate plan may include two or more trusts on the death of the first spouse to eliminate any estate taxes at that time and ensure both spouses’ estate and GST tax exemptions are maximized.
The tax consequences of passing assets along to children should also be considered. That typically means the creation of GST tax exempt trusts (using the GST tax exemption amount of $13.61 million per person in 2024), which are capable of holding assets for subsequent generations without incurring estate tax or GST tax liability, provided the assets stay in the trust.
2. Consider Annual Exclusion Gifts
When the basic elements of your estate plan are in place, it’s time to consider annual exclusion gifts. For 2024, the annual gift tax exclusion allows you to give up to $18,000 ($36,000 for married couples) each to as many people as you choose. A couple with five children could use the annual exclusion to give a total of $180,000 per year in gifts that are not taxed. In addition, you are allowed to give unlimited gifts for medical and tuition payments if they are paid directly to the provider.
Annual exclusion gifts are an impactful and straightforward way to pass assets while avoiding tax liability. They offer some flexibility, as the gifts can be given directly to the recipient or put into a trust under specific guidelines.
3. Use an Irrevocable Trust With Your Life Insurance
If you carry a life insurance policy, the tax treatment of the payouts is something you should address. Life insurance can be placed in a trust known as an ILIT, or irrevocable life insurance trust. The benefit of this is that the life insurance payment will not be taxed as part of your estate. Your beneficiaries will receive the life insurance payout without incurring unnecessary tax liability.
If you do not have life insurance but are considering it to provide an infusion of funds to cover expenses related to your passing, you may want to create an irrevocable trust to purchase life insurance to meet those needs. Again, the upside to this is avoiding estate tax liability for the life insurance payout while still achieving your goal of providing immediate financial relief to your loved ones when you pass.
An ILIT places responsibility for managing the life insurance policy on the trustee named in the document. That means the trustee would have to pay the premiums and pay out the proceeds at the proper time. Ensuring that the trust is created and funded correctly is vital, so you should secure the help of a skilled estate lawyer.
4. Maximize Lifetime Exemption Amounts
In addition to annual exemption gifts, you can make larger gifts to minimize tax liability. In 2024, an individual can transfer a total of $13.61 million at death or during their lifetime free from federal gift and estate taxes. A married couple can transfer twice that amount—$27.22 million—free of tax. But these amounts are scheduled to be cut in half in 2026.
Due to the scheduled change, you should consider taking advantage of the exemption sooner rather than later. Assets transferred now would escape the additional tax scheduled for 2026. Another advantage of transferring assets now is that, as these values appreciate, the increased value will be going to your chosen beneficiaries rather than your estate.
As with annual exclusion gifts, lifetime gifts can be given directly to the recipient or used to fund GST tax exempt trusts, which use your $13.61 million exemption for the GST tax ($27.22 million for a married couple), protecting the property from estate taxes for future generations. For married couples, spousal lifetime access trusts (SLATs) can enable you to use your exemption amounts while preserving access for your spouse during their lifetime.
Unsurprisingly, large gifts raise a number of issues you’ll want to evaluate. There are estate tax and income tax implications that should be weighed against one another. How and when your beneficiaries receive these funds is another consideration. Fortunately, trusts can be structured with your concerns in mind as well as for tax minimization purposes.
5. Charitable Giving and Tax Liability
Your estate plan can be a chance to establish or continue your philanthropic endeavors. If you want to use part of your estate to help an established charity or serve your community, you should plan ahead with taxes in mind to maximize the impact you can make.
Once you have a clear picture of what you want to accomplish, there are often a number of tools and options that can serve future generations and reduce tax liability.
One example is the choice to pass your Individual Retirement account (IRA) to a philanthropic organization instead of leaving it to your family. That way, you can escape income tax liability tied to IRA distribution upon your passing. Another option is to create charitable lead or remainder trusts, which carry the potential to transfer assets to a charity or your loved ones with minimal tax consequences.
6. Complex Estate Planning Options
Charitable giving is often used in conjunction with maximum exemptions to give the best results.
Your portfolio and your appetite for more in-depth solutions dictate whether you want to pursue advanced estate planning strategies to reduce tax liability while still accomplishing your goals. These strategies may include plans that can:
- Freeze the value of assets in a trust and pass the appreciation of those assets, free of gift or estate taxes, to your beneficiaries. Tools to accomplish this include a Grantor Retained Annuity Trust (GRAT) or a sale to an Intentionally Defective Grantor Trust (IDGT).
- Benefit from valuation discounts for lack of control, lack of marketability, and minority share by dividing assets into portions for your beneficiaries. This often applies to assets such as Family Limited Partnerships (FLP) or real estate.
- Give current or future annuity or actuarial interests in property to your beneficiaries at a discounted value, such as through a Charitable Remainder Trust (CRT), or Qualified Personal Residence Trust (QPRT).
You can use these strategies alone or in combination to transfer your assets while incurring the least possible tax liability.
Find an Experienced Estate Planner To Help Minimize Tax Liability
At the Law Office of Janet L. Brewer in Los Altos, our skilled team can help you achieve your estate planning goals in a tax-efficient manner. By choosing an attorney with extensive experience in complex estate planning, you gain peace of mind knowing that you’ve done what you can to protect your legacy. Call us at 650-325-8276 to schedule a consultation.
