The Retirement Corporation of America

Making Gifts Part Of Your Financial Future

How Much Can You Give?

JUST REMEMBER, IF it doesn't belong to you, they can't tax it. The estate tax, should it apply to you when you die, will only cover what is in your estate at the time of death.

If it has been given away, it can't be taxed. So:

•  Give gifts to enrich the lives of other people.

•  Spare yourself a possible estate tax burden by giving such gifts.

What complicates everything is the unsettled nature of the estate tax. Again, as it was written into the 2001 tax law, the estate level applies to fewer and fewer people between now and 2010. In 2010, the estate tax disappears completely. If that's all Congress added or changed in 2001, you could simply hang onto all your money and not give any of it away. With no estate tax, estates of any size would pass to your beneficiaries with nothing lost to taxation.

But, as we mentioned earlier in this lesson, that isn't all that Congress added or changed. Having eliminated the estate tax in 2010, the 2001 law restores the tax to all estates worth $1 million or more, effective in 2011.

The idea was that if the budget situation warranted it, a future Congress could write new legislation that would keep the estate tax dead and buried in 2011 and beyond. Still, you would be in big trouble if you assumed the estate tax was gone for good--only to have it reappear, big as life, at some point down the road when Congress decided it needed to raise more revenue.

So, hope for the best--but don't bet everything on the estate tax being gone forever. Don't give away everything, but make gifts along the way to help out children or grandchildren. If the estate tax stays dead, you will have done the right thing for your children. If the estate tax returns, you will have already removed some assets from your estate, and you can begin aggressively giving away more wealth so that it belongs to someone else when you die.

The Limits on How Much You Can Give

Hand in hand with the estate tax is the gift tax, which can put a heavy burden on your good intentions. If you give too much of your estate away, you will be taxed on the gift. Furthermore, while Congress has voted to repeal the estate tax in 2010, it has voted to retain the gift tax beyond that date.

The gift tax rate was set at 50 percent for 2002--the same as the estate tax rate. That declines, step by step, to 45 percent in 2007, 2008, and 2009. Then, in 2010, when the estate tax goes away, the gift tax rate falls to 35 percent.

There are two ways around having to pay this gift tax:

1. You can make gifts of up to $11,000 a year without owing a gift tax. Furthermore, you can get a lot of mileage out of that $11,000, since anyone can give anyone else a tax-free gift of $11,000 per year. If you wanted to help your children buy a first home, you and your spouse could each give $11,000 to both your child and his or her spouse. That is $11,000 times four, or $44,000 a year in all.
2. Once you get beyond that $11,000 per year, you can continue making tax-free gifts up to $1 million over your lifetime. Each gift beyond $11,000 a year does reduce the amount of your estate, which escapes estate taxation. The first $1 1/2million of your estate escapes taxation in 2004 and 2005, and so on. Give away $100,000 in any one year, and you use up $100,000 of your exemption from estate taxes.

As a practical matter, you aren't likely to want to give away more than $22,000 a year to any one recipient ($11,000 from you and $11,000 from your spouse). You are struggling to build a good retirement nest egg and, unless you have been at it for a long time or have been unusually successful in investing your nest egg, that could do serious harm to your retirement plans.

Why You Might Give Lots of Money Away

The only reason you might want to make bigger gifts now and incur the tax, is to get assets out of your estate. Any appreciation of the asset that occurs after you give it away accrues to the donee (the person you made the gift to) rather than to your estate. That's true whether you give stock or a house, through a qualified personal residence trust or any other asset. When you give away the asset, you give away all future appreciation.

Say you have a large block of stock that has greatly appreciated in value. If you sell it, you'll incur a capital gains tax. If you keep it, it will wind up in your estate, possibly subject to estate taxes. If you give the stock to a charity or an educational institution, it moves out of your estate without triggering a capital gains tax. Better still, you can take the market value of the donated stock as a charitable deduction on your income tax.

You could create a charitable remainder trust or an annuity trust. You transfer income-producing assets to a trust, which takes those assets out of your estate. The trust then pays you a fixed amount as income each year, with the remainder going to charity.

How you handle gifts depends on the size of your estate, the needs of your estate, and your own sense of philanthropy. The rules about giving away assets get very complicated once you go beyond the $11,000 annual gift tax exclusion. Creating trusts and giving away appreciated assets are best handled by an attorney skilled in trusts and estates law. An important part of any estate plan is how to make the best use of gifts to take assets out of your estate before your death.

There's another aspect of this to consider. Even if the federal estate tax vanishes, there is no reason to think that state estate or inheritance taxes are likely to vanish. Most states don't have a gift tax—meaning you can remove any amount from your estate without incurring anything like the federal gift tax.

This may all be beyond your financial abilities today. If the estate tax vanishes, you may have no good reason, except altruism, to give away part of your estate. Still, the future of the estate tax is so uncertain that you should know all about giving away wealth. Make certain that your estate planning includes a thorough discussion of gifts and the gift tax.