With gift and estate taxes poised to rise meaningfully and the exemption scheduled to plummet, high-net-worth families should consider giving to family and philanthropy this year, even if that’s sooner than they’d anticipated.
Here’s another note about strategies designed to save on taxes in light of the potential rate hike ahead in January. The focus here is on the large scheduled spike in gift- and estate-tax rates, from 35% to 55%, and the reduction in the lifetime exemption, from $5.12 million this year to $1 million in 2013. If these changes go through (which will simply require that Congress do nothing), they will upset the plans of high-net-worth families to leave family or philanthropic legacies.
One logical response would be to give as much as $5.12 million by year-end ($10.24 million for couples) while the much larger exemption is still operative. But many people (understandably) feel uncomfortable accelerating gifts in these uncertain times. What if they need the money later?
Before giving money away, it’s prudent to determine what we call the investor’s core capitalSM—the amount of money he or she needs to support spending for life, grown with inflation, even if markets are very poor. (When it comes to securing the money needed, making pessimistic assumptions about future investment returns is wise.)
The amount remaining after satisfying the investor’s core-capital requirement is what we call “additional capital.” These funds could be considered for accelerated gifting to reduce potential estate taxes.
Of course, there are risks attached to making large gifts now. If the value of the gift goes down, the gift exclusion used up can’t be recaptured. Also, eligible beneficiaries will lose the advantage of a large step-up in the gift’s cost basis.
There’s also a risk under current law that at death, the investor’s assets, including gifts, could be subject to only a $1 million estate-tax exemption. But even if this “clawback” provision remains in the tax code, the growth of assets between the date of the gift and the date of death will not be included in calculating the taxable estate.
A wide variety of gifting vehicles are available, both for family and philanthropic beneficiaries. Since transferring assets successfully involves negotiating a hurdle tied to the prevailing level of interest rates, the current low-rate environment is especially propitious for gifting.
We project that by reducing the donor’s taxable estate, a $5 million gift to a taxable trust before the end of 2012, allocated 80% to global stocks and 20% to municipal bonds, could deliver a notable benefit. We estimate an increment of more than $4 million, adjusted for inflation, over 40 years, in median markets, as the display below shows.
We also project that the benefit could increase to $10 million if the gift were made to a grantor trust, where the donor continues to pay taxes on the investment income. If the donor lives in a state with a typical state estate tax, the benefit could increase to $13 million. (As of this writing, there are a few states that levy a gift tax under any circumstances.)
In many gifting strategies, donors can apply the generation-skipping transfer tax exemption. If they do, the asset grows outside of the estate, and that growth in value does not become subject to estate taxes. Altogether, the potential advantage of a well-planned gifting strategy executed before the new year is rather remarkable.
Investors contemplating gifting (or not gifting) should discuss their circumstances with their attorneys, tax advisors and investment professionals. AllianceBernstein does not provide tax or legal advice.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
The Bernstein Wealth Forecasting SystemSM uses a Monte Carlo model that simulates 10,000 plausible paths of return for each asset class and for inflation and produces a probability distribution of outcomes. The model does not draw randomly from a set of historical returns to produce estimates for the future. Instead, the forecasts (1) are based on the building blocks of asset returns, such as inflation, yields, yield spreads, company earnings and stock price multiples; (2) incorporate the linkages that exist among the returns of various asset classes; (3) take into account market conditions at the beginning of the analysis; and (4) factor in a reasonable degree of randomness and unpredictability.
Daniel B. Eagan is Head of the Wealth Management Group at Bernstein Global Wealth Management, a unit of AllianceBernstein.