Funding the Future

Grandparents Have Many Ways to Help Loved Ones

My family has had the pleasure of welcoming the next generation of Markuses.  My almost 3-year-old niece, Lex has enough personality and style to be nicknamed “Manhattan.” And my nephew, Nathan, followed. While his personality is still developing, I’m thinking “Mr. Giggles” may be appropriate for this very happy three-month-old.

The joy they bring to the family is immeasurable. And my generous parents, like countless other clients say, “I want to see my children and grandchildren enjoy the fruits of our labors. What should we do?” The key is to gift strategically.

The current estate tax exemption is $5.43 million per person at the federal level (expected to increase to $5.45 million in 2016), but only $4 million for the state of Illinois. Illinois residents face an estate tax of 28.5 to 50 percent. So, for clients with taxable gross estates, gifting plays a critical role in wealth transfer.  Even for those with more modest means, it is important to incorporate strategic adjustments when gifting to the next generation.

Gifts – Use ‘em or lose ‘em!

On an annual basis the IRS allows you to gift a certain amount to any beneficiary, also known as an “annual exclusion gift.” In 2015 and 2016, the annual gift exclusion is $14,000 per person (or $28,000 for a married couple). Thus, grandma and grandpa could gift $28,000 to each grandchild free of gift taxes. These annual exclusion gifts are in addition to the $5.43 million lifetime gift exemption. Unfortunately, however, if a gift is not made in a particular calendar year, it cannot be rolled over to the next year. Thus, use it or lose it! For example, if grandma wanted to gift $114,000 to her grandson, $14,000 would be considered an annual gift and she would have to file a gift tax return notifying the IRS she has utilized $100,000 of her lifetime gift exemption and upon her death she will pass $5.33 million. No gift tax would be owed but the return must be filed for informational purposes.

Boo-Boos and ABC’s

Under IRC Section 2503(e), tuition payments made directly to an educational organization (for anything from private nursery schools to grad school) or healthcare provider are not treated as taxable gifts (they are not considered part of the donor’s $14,000 annual gift exclusion or $5.43 million lifetime exclusion). With respect to educational expenses, the gift tax exclusion is only for payments of tuition and not room, board or other education expenses. In addition, the payments cannot be made to reimburse someone for the expenses; payments must be made directly to the provider. To facilitate ease of payment for education and medical bills, many families are implementing “Family Credit Cards” to be used for qualified expenses. Grandma and grandpa can then use their bonus airline mileage (or other benefits) to travel with their grandchildren.

529 Plans

With college costs continuing to skyrocket, more and more clients are eager to help put money away for the lil’ peeps – and they recognize the importance of starting early. Funding a child’s education is likely the best gift one can give. A 529 Plan is a tax-advantaged investment vehicle designed to encourage saving for future educational expenses of a designated beneficiary. Key characteristics include:

•   Capital appreciation grows tax-deferred.
•   Distributions for qualified educational expenses are exempt from taxation. Qualified expenses include tuition, fees, books, most room and board, supplies and equipment required for study.
•   Many states provide state income tax deductions for all or part of the contributions of the donor. Illinois allows a state income tax deduction up to $10,000 per individual or $20,000 for a married couple filing jointly.
•   Contributions made to the 529 plan are considered taxable gifts.
•   Donors can contribute up to $70,000 (or $140,000) prorated over a five-year period and not incur a federal gift tax.
•   529 plans do not count as an asset on financial aid applications and beneficiaries.
•   Distributions not used for a qualified educational expense are subject to income tax and additional penalties.
•   Beneficiaries can be changed so as the family grows the funds can be shared with qualified family members.

UTMA Accounts

In my experience, Uniform Transfer to Minor Accounts (UTMA), or Guardian Accounts can be somewhat dangerous as assets can quickly grow over time. In many states, when a beneficiary reaches age 18, she can go to the bank and withdraw all of the funds. In some instances, I have heard tragic stories of families putting money into a UTMA account for many years and later discovering a child with special needs would not qualify for governmental assistance.  When the UTMA accounts get too large, one option is to transfer the property to a 2503(c) trust, which allows the assets to be held in trust for a minor beneficiary provided that the beneficiary has a 30 to 60 day window to withdraw all of the principal and income upon reaching the age of 21. Another option is to transfer the funds to a limited liability company managed by a parent. Keep in mind that once the funds are gifted to a minor outright, they are included in her taxable gross estate. With proper planning, clients are encouraged to look to trusts over UTMA accounts for the estate tax and asset protection benefits.

Intentionally Defective Grantor Trusts

If clients desire to gift other assets, such as interests in a closely held family business, intentionally defective grantor trusts are recommended (IDGT). These irrevocable trusts are defective for income tax purposes whereby all of the tax attributes flow back to the Grantor who created the trust. When grandpa is the Grantor who created the trust, the payment of tax liabilities are not considered gifts and additional wealth is transferred. Language can be added to the trust allowing the trustee the ability to distribute funds to the Grantor to cover tax liabilities if there is an issue with grandpa paying the tax liability in a given year. The trust is asset protected from creditors and if properly structured can be excluded from the beneficiary’s taxable gross estate, allowing the funds to pass estate tax free from generation to generation.

Depending on your particular goals, there are a myriad of creative estate planning tools available that can be customized to meet your specific needs and facilitate the transfer of wealth from generation to generation. It gives me tremendous satisfaction to help families provide security and support to their children and grandchildren.

Funding the Future

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