Tara Thompson Popernik (pictured) and Brian Wodar
Many people see December 31 as the deadline for tax-advantaged giving each year. While that’s generally true for charitable donations, it may make sense to give one type of gift as early in the year as possible—the annual exclusion gift.
One of the great freebies in the US tax code, the annual exclusion gift allows anyone to make a gift of up to $14,000 to any other person every year, without any adverse tax impact for the giver or the recipient.
But there’s a catch: to qualify for the exclusion, the gift may only be made while the giver is alive. While many families make their annual exclusion gifts late in the year (perhaps at November and December holiday gatherings), if the giver dies earlier in the year, the opportunity to make these gifts tax-free is lost.
The annual exclusion gift can be a highly effective wealth-transfer tool. Many families could complete all of their lifetime wealth-transfer goals using these gifts alone.
One simple strategy is to make annual gifts to many people. For example, a couple with three married children, each of whom has two children of their own, could make $336,000 in tax-free gifts a year—if each spouse gives $14,000 to each of their children, each of their children’s spouses and each of their grandchildren. Over the next 10 years, that’s $3.36 million; over 20 years, that’s $6.72 million that can be transferred without a tax impact. And this doesn’t even account for the inflation adjustments to the annual exclusion amount and the growth of those assets over the next 20 years, each of which should amount to significant additional growth in the value of these gifts to the beneficiaries.
Another strategy is to make these gifts to an intentionally defective grantor trust (IDGT). Doing so removes the assets from the giver’s estate but requires the giver to pay the income taxes due on the trust, effectively allowing for additional tax-free gifts.
A third strategy takes advantage of a special rule that allows making as many as five years’ worth of annual exclusion gifts at once to a 529 tax-deferred college-savings plan to front-load the funding of the plan. Each spouse of a couple could give each of their six grandchildren five years of $14,000 gifts—or a total of $840,000—without adverse tax impact.
The annual exclusion gift does not reduce the applicable exclusion amount (also known as the unified credit, currently $5.34 million per person) for estate tax purposes. It does not result in a gift tax to the giver, and it does not create taxable income for the recipient. It is also entirely separate from the so-called ed-med exclusion—the ability to pay for qualified educational and medical expenses on a tax-free basis.
The views expressed herein do not constitute, and should not be considered to be, legal or tax advice. The tax rules are complicated, and their impact on a particular individual may differ depending on the individual’s specific circumstances. Please consult with your legal or tax advisor regarding your specific situation.
Tara Thompson Popernik is Director of Research and Brian Wodar is Director of the Wealth Management Group at Bernstein Global Wealth Management, a unit of AllianceBernstein.