By Paula Pant.
You're in your golden years, and you're thinking hard about estate planning. You want to leave gifts for your heirs, but should you wait until you pass away? Or should you give some money to them now?
First, let's review the rules:
Gift Tax vs. Estate Tax
Gift tax is the tax imposed by the federal government on any transfer of property to an individual without receiving any consideration in return. Property in this sense includes both tangible property and intangible gifts like stocks, real estateand, yes, money.
Currently (under 2014 law), you are exempt from gift tax on lifetime donations up to $5.34 million. Once your donations go over that lifetime amount, they can be subject to taxes up to 40 percent.
Estate tax is the tax imposed by the federal government on any transfer of property (tangible or intangible) by your estate after you have passed.
It is calculated by figuring out your gross estate (all assets including real estate, cash and securities, business interests, etc.) and subtracting any deductions you may qualify for (such as funeral expenses and some charitable contributions). The net amount after these calculations is then added to any taxable gifts you have given to generate your taxable amount. Finally, a unified credit (roughly between $1,000-$3,000) is applied based on your qualifications.
Next, let's talk about the pros and cons of gifting now as opposed to later:
Giving Heirs the Money Now
Here are some advantages to giving your heirs money while youre still alive.
You get to see them enjoy it. If youd prefer to see your gifts in action, giving them the money now gives you a chance to see the difference it makes in their lives.
You can advise/guide how they spend it. If youd prefer to see your gifts in action in a specific way, giving the money while youre still alive gives you a chance to let your heirs know how youd prefer they spend it.
You can give the gift in the form of paying for something. If you really want to ensure the money is spent on the thing you want it to be spent on, you can pay for something rather than giving your heirs the money for it.
For instance, you can pay for their wedding, make a down payment on their dream house, or pay for their tuition (which, incidentally, can qualify for the educational exclusion from gift tax).
You can stop giving them money if you see them falling off the rails. If you plan on giving your heirs free reign to do what they like with their money, giving it to them now allows you to put a stop to the cash flow if you see them spending it unwisely (like buying a flashy car instead of paying for tuition or paying down their mortgage).
You can avoid taxes up to a certain amount. For 2014, the IRS allows you to exclude up to $14,000 in gifts per heir (or $28,000 per heir if the gift is given by you and your spouse jointly). This means you will not have to pay gift tax on gifts up to that amount.
Waiting Until You Pass Away
Conversely, here are some advantages to waiting until you pass away before bequeathing gifts to your heirs.
You may need the money later. What if you find that you need the money to pay for your own expenses during your lifetime? You might need more than you think in order to enjoy your (hard-earned) retirement, pay for medical expenses not covered by insurance, or cover other long-term care costs.
More favorable tax treatment. That $14,000 annual gift tax limit is nice, but estate tax has a $5 million lifetime exemption. (Estate transfers most commonly happen upon death, but you should speak with an estate-planning attorney and a CPA before you make any decisions.)
Ability to change your mind. At the moment, you might want to split your money equally among your children (or other heirs). But what happens if one of your children later adopts self-destructive behaviors, or makes poor decisions, that makes you want to disinherit that person? Conversely, what happens if one of your children gets into a major accident and requires more medical care, and therefore more financial support?
You can always adjust your will to change the amount youll be leaving heirs after you pass away, but you cant take back money youve already gifted. Waiting until you pass away gives you the opportunity to change your mind during your lifetime.
Your heirs might appreciate it more/spend it more wisely. By waiting until youve passed, you give your heirs a chance to make their own way in the world at a younger age. Rather than relying on an annual cash infusion from you, your heirs will be older and more responsible when they receive the inheritance. This might cause them to appreciate the gift more, since theyve experienced the task of earning money. (On the other hand, it may not. Its hard to predict how responsibly a person will act, regardless of their age.)
Which Should You Choose?
Should you give your heirs gifts now? Or wait? Ultimately, theres no right answer. This is a personal choice.
Heres one idea: If youre financially secure (e.g. if you have a pension from a stable institution, such as a government pension), then go ahead and give some of your inheritance now. This will allow you to direct the way that the money is spent. You can specifically make sure that your money is used to help your heirs make a downpayment on a house, pay for a wedding, or cover tuition costs.
But your retirement and elder-care expenses must come first. The greatest gift that you can give your family is your own personal financial stability during your golden years. If your own retirement is in question, then keep your money during your lifetime. You may need it to cover your own costs, and you dont want to be financially stressed at age 70, 80 or 90.
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