Warren Buffett recognized the importance of planning and taking action now to benefit future generations when he famously said, "Someone's sitting in the shade today because someone planted a tree a long time ago." For individuals with substantial estates, the decision to make financial gifts during one’s lifetime is not just an act of generosity, but a strategic move that can offer significant tax benefits while providing for future generations. Lifetime gifting provides for the reduction of taxable estates, thereby minimizing the potential tax burden on heirs while enabling the donor to witness the impact of their gifts during his or her lifetime.
At Cedar Point Financial Services LLC, we work with our clients and their advisors in developing strategies for lifetime gifting. Often, these strategies include how to best use an individual’s annual and lifetime gift tax exclusions in conjunction with an irrevocable trust while determining whether or not purchasing life insurance should be considered.
The Rationale Behind Lifetime Gifting
One of the most compelling reasons for making financial gifts during one’s lifetime is the opportunity to reduce the taxable value of his or her estate. By transferring assets to family members or into trusts, the donor effectively reduces the size of his or her estate, which can result in a lower estate tax liability upon death. Furthermore, gifting during one’s lifetime allows the donor to enjoy seeing the benefits of their gifts, such as funding a grandchild’s education or helping a child start a business, all while potentially reducing the overall tax burden.
In 2024, the gift and estate tax exemption is set at $13.61 million per individual ($27.22 million for a married couple), allowing significant wealth transfer without incurring gift taxes. However, this exemption is scheduled to sunset at the end of 2025, reverting to a lower amount unless Congress takes action to extend the current law. This impending change creates a sense of urgency for wealthy individuals to take advantage of the current outsized exemption levels by making substantial gifts before the scheduled decrease.
Annual and Lifetime Gift Tax Exclusions
The IRS allows individuals to make gifts up to a certain amount each year without triggering gift taxes or requiring the filing of a gift tax return. In 2024, the annual gift tax exclusion amount is $18,000 ($36,000 for a married couple electing to split gifts) per recipient. This exclusion provides a straightforward way to transfer wealth incrementally, reducing the size of the taxable estate over time.
For those with larger estates, the lifetime gift tax exemption offers a more substantial opportunity for wealth transfer. The lifetime exemption, which is currently unified with the estate tax exemption, allows each individual to give away up to $13.61 million without incurring gift taxes. However, any use of this exemption during lifetime reduces the amount available to reduce estate taxes upon death.
Gifting to Irrevocable Trusts and Life Insurance Strategies
One effective strategy for maximizing the benefits of lifetime gifting involves using the annual and lifetime gift tax exclusions to fund an irrevocable trust, which can then be used to purchase life insurance. An irrevocable life insurance trust (ILIT) offers several key advantages, including keeping the life insurance proceeds out of the taxable estate, thus preserving the full value of the death benefit for heirs.
When structured properly, grantors can gift the annual exclusion amount or utilize all or part of their lifetime exemption to the ILIT, which then uses those funds to pay the premiums on a life insurance policy. Upon the grantor’s death, the policy’s death benefit is paid to the trust, providing an income tax-free inheritance to the beneficiaries. This strategy is particularly beneficial for funding future generations, as the life insurance proceeds can be distributed according to the terms of the trust, ensuring that the grantor’s wishes are carried out and that wealth is protected from creditors for heirs.
Contact Cedar Point Financial Services LLC to learn more about different tax-efficient strategies, tying together gifting, trusts, and life insurance to benefit your or your client’s individual situation.
Generation-Skipping Transfer (GST) Trusts
A generation-skipping trust (GST) is an often-used tool for those looking to preserve wealth for future generations, particularly grandchildren and beyond. When assets are placed into a GST trust, they can skip the next generation (typically the grantor’s children) and pass directly to the grandchildren, effectively avoiding estate taxes at the children’s generation.
However, one key consideration when establishing a GST trust is the tax treatment of the trust’s income. As long as the grantor is alive, the trust is considered a grantor trust, meaning the income is taxed to the grantor at their individual income tax rates. Upon the grantor’s death, the trust loses its grantor trust status, and any income generated by the trust becomes subject to the highly compressed tax brackets applicable to trusts, where income over $14,450 is taxed at the top rate of 37% as of 2024.
This potential tax burden can be mitigated by using life insurance within the trust. Since life insurance cash value grows tax-deferred and the death benefit is typically received income tax-free, the trust can benefit from the policy’s proceeds without generating taxable income. This not only preserves more wealth for the beneficiaries but also addresses the issue of the trust’s income being subject to punitive tax rates after the grantor’s death. Our clients and their advisors seeking to protect wealth across several generations work with Cedar Point Financial Services LLC on life insurance-based solutions to achieve this goal.
Addressing the Lack of a Step-Up in Basis
Another critical aspect of estate planning involves the tax implications of transferring highly appreciated assets. Generally, when assets are passed through an estate, they receive a step-up in basis, which adjusts the asset’s cost basis to its fair market value at the time of the decedent’s death, effectively eliminating any capital gains tax if the asset is sold shortly thereafter.
However, assets transferred through a gift during the grantor’s lifetime do not receive this step-up in basis. Instead, the recipient inherits the donor’s original cost basis, potentially exposing them to significant capital gains tax upon sale. By transferring cash or using the gift (and/or income generated by it) to fund a life insurance policy within an ILIT or GST trust, this issue can be avoided. The life insurance proceeds are received income tax-free, thus bypassing the capital gains tax entirely and preserving more wealth for the trust’s beneficiaries.
We Are Here to Help
Lifetime gifting is a strategic component of estate planning that offers numerous benefits for affluent individuals seeking to reduce their taxable estates while providing for future generations. By leveraging annual and lifetime gift tax exclusions and utilizing tools such as irrevocable trusts and life insurance, donors can maximize the after-tax value of their gifts and ensure that their wealth is preserved for their children, grandchildren, and beyond.
Moreover, careful planning can mitigate the impact of trust income taxation and the lack of a step-up in basis for gifted assets, further enhancing the effectiveness of these strategies. As tax laws and exemptions are subject to change (as soon as the end of 2025), it is crucial for individuals to work closely with their estate planning advisors, including the life insurance experts at Cedar Point Financial Services LLC to take advantage of current opportunities and ensure their plans align with their long-term financial goals. At Cedar Point Financial Services LLC, we work with clients’ legal, accounting, and other advisory professionals in developing and implementing strategies that optimize their clients’ individual and business financial plans.