Un-Used Annual Gift Tax Exemption

The annual federal gift tax exclusion for 2022 was raised to $16,000 per individual (from $15,000 in 2021). The new cap expands the opportunity to gift cash, securities or other asset annually, up to that threshold to your heirs tax-free and without filing a gift tax return. This can be a valuable estate planning opportunity for many taxpayers. Consider the example of the married couple John and Maria:

John and Maria

John: Age 64, retired business owner
Maria: Age 61 retired volunteer
Children: 2

The case details

John owned a service company and sold it four years ago, amassing net worth at a level significant enough to provide for his and his wife’s income needs for the rest of their lives, with assets left over for the next generation. John and Maria are retired and enjoy an active lifestyle. They have insurance policies through an irrevocable life insurance trust (ILIT), and the premiums are paid from ILIT assets that were gifted to them years ago. This gift used up nearly all of their lifetime estate tax exemption (currently $24.12 million for a married couple). They have two adult children and their primary goal is to pass as much wealth to them  as possible with the greatest tax efficiency.

The Solution

John and Maria do not currently engage in annual gifting to their kids. For 2022, they have the opportunity to gift up to $16,000 per spouse, per child, per year without having to file a gift tax return or potentially pay gift tax, on $64,000. Although they can gift the $64,000 to their kids directly, they decide instead to gift it to their ILIT, which will own a newly purchased life insurance policy with the children as the sole beneficiaries.

The survivorship life insurance policy with a $64,000 annual premium will provide a tax-free death benefit* of $4,385,000.

Why the solution fits the situation

• John and Maria are conservative investors and invest the majority of their assets in moderate risk portfolios and fixed income. The internal rate of return (IRR) on the life insurance is 3.32% at life expectancy. Because their tax rate is 40%, the taxable equivalent of the IRR is 5.53% (IRR of 3.32% / Tax Rate factor 0.60%).
  •  This life insurance product is guaranteed* to age 120, which makes the IRR guaranteed and highly attractive for their risk tolerance and expectations.

• The beneficiaries of the ILIT can get access to the cash value of the life insurance policy in the form of withdrawals and loans should they need capital.

Summary

• The clients were able to accomplish their main goal of passing value to the next generation in a tax-efficient way.
• The clients secured a tax-free, guaranteed death benefit of $4,385,000*.
• The guaranteed death benefit* taxable equivalent IRR of 5.53% is greater than the yield on the fixed income portfolio, which makes it an attractive return for their long-term planning.
• The clients were able to reduce their taxable estate by $64,000 annually, essentially saving 40% of every dollar that would otherwise go to federal estate taxes.
• They were able to place the assets in a trust that gives the beneficiaries access to cash values.

For more information on how you can take advantage of the annual gift tax exemption, contact Greg Lopez at 440.459.5833.