My friends, a retired couple age 70, currently have an estate worth $20 million. You might think an estate of that size means their heirs are worry-free, but if they were to die tomorrow, their kids would find themselves writing a check for millions of dollars to the federal government. Why? Because current law only allows an individual to pass along up to $5.45 million in assets tax-free, or up to $10.9 million for a married couple who share their lifetime exclusion. This might not sound so bad given that the estate tax exemption was a measly $1 million back in 2011, but when you’ve worked hard to provide a good life for your kids and grandkids, no one wants to see an unreasonable share of that go to the government.  

Fortunately, there are a number of ways you can safeguard your money. One way is to take advantage of the annual gift exclusion, which reduces the size of your taxable estate while you’re still alive, creating a larger legacy for your heirs. And if you use the annual gift exclusion to fund a life insurance policy, you’ll see even more benefits for your estate.

What Is the Annual Gift Exclusion?

The annual gift exclusion is the amount of money that the IRS allows you to give away at one time without having to do a gift tax filing. That amount is currently $14,000 per year, or $28,000 for a married couple. That amount can be given to any number of people. For example, my friends have two kids and four grandkids, which means they could give away up to $168,000 each year, at a rate of $28,000 for each child and grandchild.  

Individuals and couples utilizing the annual gift exclusion can really save a fortune with it. Let’s take the above $20 million estate as an example. Let’s say my friend Jim passes away and his wife Barbara passes away two years later. Barbara’s estate can shield up to $10.9 million from federal estate and gift taxes using current portability laws, which allow her to utilize not just her own exemption, but Jim’s unused exemption as well. That still leaves their heirs with $9.1 million of assets exposed to the estate tax.  

Now, let’s say Jim and Barbara had given away $168,000 each year for the past ten years to both kids and all four grandkids. They would have ultimately given away $1.68 million and reduced the amount of their estate being exposed to taxes from $9.1 million to $7.42 million. With a top tax rate of 40%, we’re talking about nearly $700,000 saved, just by giving money to people who they were planning to give it to anyway!

Using Life Insurance to Gain Leverage

If you’re really determined to brighten the financial futures of your heirs, gifting all of that money into a life insurance trust is the way to go. Instead of simply writing checks to be deposited into bank and brokerage accounts—where they could lose money in the stock market—putting that $168,000 to work each year in a life insurance policy will purchase 10 million of life insurance on a Survivorship or Second-to-Die basis. This will be far more beneficial than the  $700,000 of tax savings that the simple gifting strategy above illustrates. In fact, if you think about the taxable equivalent of a tax-free $10 million, it could be $20 million or more, once you factor in the federal and state taxes that would be due. This will create a much more substantial legacy to be shared by the various beneficiaries in the future than simply gifting alone. The uses for that money are endless—anything from college educations to down payments on real estate, or seed capital to start a business. This type of “purposeful giving” is very, very powerful.

Funding a life insurance policy through an irrevocable trust (ILIT) can have distinct advantages over owning the policy directly. The main advantage is to ensure that the insurance proceeds (the death benefit) will be viewed outside of the insured’s estate, meaning those proceeds won’t be exposed to estate taxation. This is done by using an irrevocable trust where any incidents of ownership are avoided. The trust also allows for more specific language regarding the collection and eventual disbursement of the funds. Needless to say, an ILIT should be carefully drafted by an estate planning attorney with experience in this area.

If you’re interested in reducing the size of your estate and increasing your legacy with life insurance, taking advantage of the annual gift exclusion is just one strategy that can accomplish both of these objectives. To review your estate plan with one of our experts, please don’t hesitate to contact us today.

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